How The Market Can Detect Its Own Mispricing - A Sentiment Index To Detect Irrational Exuberance

The emergence of big data analytics enables real \ time news analysis. Such analysis offers the possibility to instantly \ extract the sentiment conveyed by any newly published, \ textual information source. This paper investigates the existence \ of a causal relationship between news sentiment and stock \ prices. As such, we apply news sentiment analysis for unstructured, \ textual data to extract sentiment scores and utilize \ the Granger-causality test to determine the causal relationship \ between daily news sentiment scores and the corresponding \ stock market returns. Upon successfully identifying such a \ causal relationship with a time lag, we develop a real-time \ news sentiment index. This news sentiment index serves as \ a decision-support system in detecting a potential over- or \ undervaluation of stock prices given the news sentiment of \ available news sources. Thus, as a novelty, the news sentiment \ index serves as an early-warning system to detect irrational \ exuberance

Behavioral economics and real estate bubbles: a systematic literature review

O fenómeno de bolhas especulativas possui uma longa história, documentado pela primeira vez em 1637, associado ao episódio histórico da Mania das Tulipas. Após esse evento, a nossa sociedade tem enfrentado inúmeras bolhas, surgindo maioritariamente no mercado de acções e mercado imobiliário. As bolhas imobiliárias mais famosas são: a bolha imobiliária Japonesa da década de 80 e a bolha imobiliária dos Estados Unidos, no início dos anos 2000. Estes fenómenos de preços tiveram um impacto devastador não só na economia dos países em questão, como também na economia de outros países. Até agora, bolhas especulativas constituíam uma área de estudo carente de investigação, onde certos conceitos ainda se encontram por definir, e um relato claro dos factores que influenciam e aceleram o fenómeno de bolhas especulativas está em falta. Observações empíricas provam que as teorias clássicas e conceitos fundamentais da literatura financeira ficam aquém de uma explicação da natureza de bolhas especulativas. Diversos argumentos relacionados com estes fenómenos foram propostos, mas acordo entre especialistas ainda não foi aceite. Por exemplo, Rober Shiller (2004) acredita que irracionalidade exuberante foi proclamada como uma das principais forças por detrás do surgimento de uma bolha no mercado imobiliário Estadunidense, nos anos 2000. Por volta da mesma altura, Eugene Fama (2010) expressou cepticismo acerca da existência deste fenómeno, motivado pelo facto de que prever e evitar bolhas não é possível. A teoria de economia comportamental emerge como uma estrutura teórica que possibilite o enquadramento do fenómeno de bolhas na literatura, melhorando assim os estudos efectuados nesta área. O conceito básico da teoria comportamental é o de que participantes num mercado financeiro são por natureza irracionais e sofrem de preconceitos a nível psicológico, resultando em decisões monetárias que aparentam irracionais, especialmente quando as condições de risco e incerteza são tidas em conta. Economia comportamental baseia-se na Teoria da Perspectiva, desenvolvida por Kanheman e Tversky in 1979, e oferece uma alternativa à existente Teoria de Utilidade Expectável. A ideia principal é a de que os participantes do mercado são irracionais por natureza. Outros conceitos de teoria comportamental são: os limites da arbitragem, como alternativa à Hipótese do Mercado Eficiente; os limites psicológicos e preconceitos cognitivos dos participantes do mercado. Apesar do campo das finanças comportamentais se encontrar bem estabelecido, prevalece ainda a abordagem de racionalidade perante um mercado e a dificuldade em quantificar fenómenos psicológicos e sociológicos, inerentes à noção de “exuberância irracional”, que contribuem para a escassez de estudos comportamentais. Quando aplicado ao mercado imobiliário, o número de estudos é cada vez mais restrito. A razão principal encontra-se nas características específicas do mercado, que dificultam a colecção de informação estatística suficiente para efectuar estudos empíricos. Esta dissertação representa uma revisão sistemática da literatura pertinente à aplicação da teoria comportamental e conceitos associados de modo a compreender e explicar a natureza de bolhas imobiliárias. Os objectivos principais da revisão sistemática são: 1. Efectuar uma revisão da literatura existente acerca destes dois tópicos, bolhas imobiliárias e teoria comportamental, de modo a definir a questão de investigação e especificar as palavras-chave mais apropriadas para a selecção dos artigos; 2. Apresentar uma estratégia de selecção dos artigos mais relevantes relacionados com a questão de investigação, que é a aplicação de teoria comportamental ao estudo da natureza das bolhas imobiliárias; 3. Definir e discutir os resultados mais importantes da selecção de artigos relacionados com o tópico; 4. Definir as oportunidades e desafios para futura investigação empírica relacionada com o tópico. A metodologia utilizada foi uma revisão sistemática da literatura, que procura minimizar as fraquezas presentes na revisão tradicional da literatura. Revisões sistemáticas são formas rigorosas e transparentes de rever a literatura. Envolvem identificar, sintetizar e avaliar todas as evidências disponíveis, quantitativas ou qualitativas, de modo a gerar uma resposta robusta e empiricamente derivada que responde à questão de investigação. Cada passo do processo de selecção está presente de acordo com o protocolo padrão de uma revisão sistemática. Os critérios de inclusão e exclusão encontram-se igualmente presentes e são estritamente seguidos durante a selecção dos artigos. A pesquisa actual começa no estudo da literatura existente relacionada com os dois tópicos do trabalho, que são: economia comportamental e bolhas no mercado imobiliário. O objectivo principal é avaliar todo o conhecimento existente em ambas as áreas de modo a definir as possíveis lacunas neste conhecimento e como é que a aplicação de teoria económica comportamental pode auxiliar no entendimento da natureza das bolhas. A motivação principal para tal sinergia entre as duas áreas é o facto de que teorias económicas tradicionais não são suficientes para explicar bolhas especulativas como fenómenos. A revisão sistemática da literatura foi possível utilizando como recurso a base de dados Web of Science. A extensão inicial de artigos encontrados com a aplicação das palavraschave foi de 936 artigos. A aplicação de critérios de exclusão, parcialmente feita com o uso de filtros proporcionados pela própria base de dados (linguagem, tipo de documento, área científica), e através da leitura dos abstracts de cada artigo. O resultado da aplicação dos critérios de exclusão foi de 35 artigos. Os critérios de inclusão, aplicados ao ler cuidadosamente o texto de cada artigo na sua totalidade, levou à eliminação de 18 artigos. O conjunto final de artigos é composto por 17. A síntese dos artigos seleccionados mostra que existem provas empíricas que corroboram a correlação entre factores comportamentais e variações de preços durante as bolhas imobiliárias. Encontrou-se provas de que a teoria comportamental pode se revelar eficiente em explicar a natureza da bolha e factores psicológicos devem ser incluídos nos modelos tradicionais de precificação de activos financeiros de modo a melhorar o conhecimento que se tem acerca das bolhas imobiliárias. O desafio que surge da aplicação de conceitos comportamentais é o de que preconceitos psicológicos e seus efeitos são difíceis de medir e quantificar, e dados estatísticos difíceis de colectar. O mercado imobiliário, devido às suas particularidades, também apresenta algumas dificuldades em agregar dados estatísticos. Por exemplo, a baixa liquidez do mercado e certos limites nas transacções permitidas no mercado, restringem consideravelmente a quantidade de dados estatísticos necessários para uma investigação empírica.Background: The behavioral economics theory relies on the concept, that market participants are irrational by their nature and suffer from psychological limitations and cognitive biases. As a result, the money related decisions might be irrational and errored, especially if done under risk and uncertainty. According to the behavioral concept, the real estate market is partially represented by the unsophisticated households and speculative agents. The irrational behavior of such participants might cause sharp deviations of the house prices from the fundamental value and even cause the bubble. The traditional theories and fundamentals are not sufficient enough for studying the nature of the house bubbles. So, behavioral theory is seen as the useful framework for better understanding of the factors, that stand behind the bubble formation. Objective: The goal of this dissertation is to assess the application of the behavioral economics theory to the explanation of the real estate bubbles nature. Method: A systematic literature review was performed in order to identify and assess the application of behavioral economics theory. Results: The initial search, based on the key words, showed 936 papers, that potentially referred to the studied topic. Among these papers, only 17 met our inclusion criteria. The analysis of the selected papers shows that the behavioral factors are correlated with the price deviations during the recent house bubbles and are able to improve the explanation of the nature of the phenomena. Conclusion: After conducting the systematic literature review, we can sum up that behavioral factors should be implemented in the traditional asset price models to improve better understanding of the house bubbles´ nature. The result of our literature review shows what has been done and what can be done in this field. In general, the narrow volume of the final set of the papers means the paucity of the existing studies on application of behavioral approach to the real estate bubbles. The reasons for that are: the prevalence of the traditional theories; complications related to measuring and quantifying the behavioral factors; the relatively low liquidity of the real estate market, that make it difficult to collect the sufficient set of statistical data

Essays on American Depositary Receipts: New Fears, Investor Attention and Financial Bubbles

This dissertation consists of four chapters, focusing on American Depositary Receipts (ADRs) and how they are affected by new measures of investor sentiment, new proxies of investor attention, and financial bubble detection. ADRs are negotiable certificates of ownership in foreign companies that are traded in the U.S. financial markets. In Chapter I, I make a brief introduction of ADRs. The types of programs there are, the market capitalization and volume in general and to some specific countries. In Chapter II, I show that negative investor sentiment measures, derived from internet aggregate search indices, have a contemporaneous negative effect on ADR stock indices and a second-day reversal behavior. To build the sentiment measure, I apply a similar methodology developed in recent literature to construct the Financial and Economic Attitudes Revealed by Search (FEARS) index. Moreover, evidence shows that this effect is greater for Latin American ADR indices at the aggregate level and on a country-specific level than for other regions. After matching the sample during times of turmoil, the results are consistent with the literature that employs this sentiment proxy with U.S. stock indices. In Chapter III, I examine the effect of country-specific investor attention on ADR mispricing. Investor attention is measured by the amount of traffic a country profile receives on Wikipedia. A 2-Stage Least Squares (2SLS) model is employed to mitigate the potential endogeneity. Evidence shows that higher levels of investor attention have a negative impact on ADRs mispricing. In Chapter IV, I utilize the Generalized Supremum Augmented Dickey-Fuller test methodology to identify and time-stamp the beginning and the end of financial bubbles in ADR stock indices. Evidence shows that there are multiple bubble episodes in the general ADR index, which correspond to bubble episodes in the S&P 500 during the preceding months of the 2008-2009 financial crisis. Moreover, I also identify several bubble periods on Latin American, European, and Asian ADR indices

Investor Sentiment in the Stock Market

Real investors and markets are too complicated to be neatly summarized by a few selected biases and trading frictions. The "top down" approach to behavioral finance focuses on the measurement of reduced form, aggregate sentiment and traces its effects to stock returns. It builds on the two broader and more irrefutable assumptions of behavioral finance -- sentiment and the limits to arbitrage -- to explain which stocks are likely to be most affected by sentiment. In particular, stocks of low capitalization, younger, unprofitable, high volatility, non-dividend paying, growth companies, or stocks of firms in financial distress, are likely to be disproportionately sensitive to broad waves of investor sentiment. We review the theoretical and empirical evidence for these predictions.

Empirical studies of financial and labor economics

This dissertation consists of three essays in financial and labor economics. It provides empirical evidence for testing the efficient market hypothesis in some financial markets and for analyzing the trends of power couples’ concentration in large metropolitan areas. The first chapter investigates the Bitcoin market’s efficiency by examining the correlation between social media information and Bitcoin future returns. First, I extract Twitter sentiment information from the text analysis of more than 130,000 Bitcoin-related tweets. Granger causality tests confirm that market sentiment information affects Bitcoin returns in the short run. Moreover, I find that time series models that incorporate sentiment information better forecast Bitcoin future prices. Based on the predicted prices, I also implement an investment strategy that yields a sizeable return for investors. The second chapter examines episodes of exuberance and collapse in the Chinese stock market and the second-board market using a series of extended right-tailed augmented Dickey-Fuller tests. The empirical results suggest that multiple “bubbles” occurred in the Chinese stock market, although insufficient evidence is found to claim the same for the second-board market. The third chapter analyzes the trends of power couples’ concentration in large metropolitan areas of the United States between 1940 and 2010. The urbanization of college-educated couples between 1940 and 1990 was primarily due to the growth of dual-career households and the resulting severity of the co-location problem (Costa and Kahn, 2000). However, the concentration of college-educated couples in large metropolitan areas stopped increasing between 1990 and 2010. According to the results of a multinomial logit model and a triple difference-in-difference model, this is because the co-location effect faded away after 1990

CAPM and Irrational Market: Theories and Empirical Studies

With a new interpretation of the Capital Asset Pricing Model (CAPM), this dissertation explains that the CAPM has an implied assumption of no mispricing. The CAPM should work if mispricing is removed from all assets in the market, leading to the Rational CAPM. The Rational CAPM measures value changes of the market, and then yields value changes of an asset/portfolio by employing value changes of the market in the model. For the Rational CAPM, this dissertation explains that risk, mispricing, irrationality and (investor) sentiment all indicate the same. Using the value changes from the Rational CAPM and historical dividend yields, this dissertation demonstrates how to measure values and bubbles in historical data, leading to the Ex-post Bubble Model (EBM). By the EBM, this dissertation reveals how irrationality forms, develops and reduces bubbles. Based on the Rational CAPM and the EBM, empirical studies are conducted into the U.S. stock market to verify the validity of these models. The results from the U.S. stock market provide the evidence that both Rational CAPM and EBM work with historical data

Investor sentiment in the stock market

The history of the stock market is full of events striking enough to earn their own names: the Great Crash of 1929, the ’Tronics Boom of the early 1960s, the Go-Go Years of the late 1960s, the Nifty Fifty bubble of the early 1970s, the Black Monday crash of October 1987, and the Internet or Dot.com bubble of the 1990s. Each of these events refers to a dramatic level or change in stock prices that seems to defy explanation. The standard finance model, in which unemotional investors always force capital market prices to equal the rational present value of expected future cash flows, has considerable difficulty fitting these patterns. Researchers in behavioral finance have therefore been working to augment the standard model with an alternative model built on two basic assumptions

Essays on the dynamics of stock returns in emerging markets: Roles of volatility and sentiment in Turkey

Emerging stock markets play an important role in portfolio diversification. Accurate depiction of their status is essential for potential investment assessment. This dissertation focuses on two important aspects of emerging markets using Istanbul Stock Exchange (“ISE”) as an example: modeling stock return volatility as a measure of risk and exploring potential interaction between stock returns and consumer/business sentiments. ISE is selected as it has no entry restrictions and offers great investment potential with 65% foreign participation. The first essay focuses on stock return volatility. Potential asymmetric behavior is investigated by looking into how the ISE National-100 Index prices evolve over time and how market participants react to sudden good or bad news. Whether these reactions are priced in the ISE National-100 Index is also confirmed. There are three distinctions from previous studies: (1) Student’s t distribution is used in error terms, which is more suitable for non-linear data, (2) Both magnitude and direction of asymmetry is analyzed rather than just direction, and (3) the longer sample period allows more in-depth analysis. The findings suggest that the ISE is inefficient with strong dependencies in stock prices and depicts persistent and asymmetric volatility behavior. The second essay investigates the bidirectional relationship between consumer/business sentiments and the ISE National-100 Index returns. This is the first study in ISE that treats the sentiment as a joint function of fundamentals-driven and irrationality-driven risk factors and probes the concurrent impact of each component on the ISE National-100 Index returns. It also extends the current literature by incorporating the capital asset pricing model into the calculation of excess returns to validate the findings’ robustness. The findings for the second essay support the rational expectations theory that fundamental risk factors have more pronounced and significant effects on stock returns than irrational risk factors. Dissertation’s findings imply that the ISE has significant potential for future growth as the number of participants and efficiency increase in the market