The Reaction of Stock Returns to News about Fundamentals

This paper analyzes the reaction of stock returns to news about the state of the economy. We develop a general equilibrium asset pricing model where the investor learns about the growth rate of the economy through two sources of information, dividend realizations and regularly scheduled announcements about the state of the economy. We distinguish between dividend news and the unexpected part of the external signal and characterize the reaction of stock returns to news from these two sources of information. We show that the reaction to these news variables can be quite different under different assumptions about their precisions in different states. Our model is able to account for several empirical facts about the reaction of stock returns to news, such as time-varying and state-dependent reaction, asymmetric reaction to extreme news and stronger reaction to more precise signals.Regime Switching, Asymmetric Reaction, Dividend News, Public Announcements

Is News Sentiment More Than Just Noise?

Big Data analytics has recently fostered significant research on the influence of news sentiment in finance. This paper thus examines the effect of news sentiment on crude oil prices for different investor types according to the noise trader approach. The noise trader approach assumes the presence of informed and uninformed investors. Informed investors possess a perfect information horizon, whereas uninformed investors trade upon noise signals, such as sentiment. Methodologically, we decompose the crude oil price with a Kalman filter into a Kalman-smoothed, fundamental price component and a noise residual. We then regress news sentiment on both decomposed oil price components. Our findings suggest that news sentiment not only has a significant positive effect on the noise residual (as suggested by the noise trader approach), but also on the fundamental price. Thus, we find empirical evidence contradicting the noise trader model, which assumes that only uninformed investors trade on sentiment

Information Processing of Foreign Exchange News: Extending the Overshooting Model to Include Qualitative Information from News Sentiment

In a globalized world, the volume of international trade is based on both import and export prices, thereby making a country\u27s economy highly dependent on exchange rates. In order to study exchange rate movements, one frequently exploits the so-called Dornbusch overshooting model. However, the model is controversial from a theoretical point of view: it presupposes the processing of information, though this is not directly reflected by the underlying variables. As a remedy, this paper investigates a potential cognitive bias by including textual news content, thus adjusting for information dissemination. As such, we perform a multivariate analysis to compare the classical overshooting model with an extended variant that includes news sentiment. Our results show that news has a substantial explanatory power of 11% of the exchange rate forecasting error variance. In addition, we also find statistical evidence that a shock in news sentiment may lead to overshooting

Monetary policy, investor sentiment and stock returns

This doctoral thesis empirically investigates the response of the U.S. market-wide and cross- sectional stock returns to monetary policy shocks after the Federal Open Market Committee (FOMC) meetings, across different sentiment states between June-89 to October-14. It also examines the impact of investor sentiment states on the market-wide stock price drift before the scheduled FOMC announcements. Chapter 1 demonstrates that the state of investor sentiment strongly affects the transmission of conventional and non-conventional monetary policy to the stock market. In particular, monetary policy shocks significantly affect market-wide stock returns only during sentiment- correction periods. In contrast, during periods of optimism build-up, the stock market response is statistically insignificant. The sentiment-based state dependence in the response of stock market returns to monetary policy shocks sheds important light on a sentiment channel in the monetary policy transmission mechanism. We extend our empirical analysis to cross-sectional stock returns in Chapter 2. Our estimates show that monetary policy shocks significantly affect cross-sectional stock returns only during sentiment-correction periods. We construct a long-short strategy, according to which we define the stocks which are more exposed to investor sentiment as the short leg. Our results show that monetary policy shocks positively drive the long-short spread, with a larger impact on the short leg stocks. Specially, Federal Funds Rate (FFR) surprises have larger impacts on the stocks with high accruals, young stocks, stocks with high asset growth rate, stocks with low book-to-market ratio, stocks with high cash to asset ratio, stocks with low gross profitability, high investment stocks, past loser stocks, stocks with high net operating assets, stocks with low asset tangibility, less profitable stocks, stocks with high return volatility, and large stocks before the zero lower bound (ZLB) was reached. The long-short strategy is reconstructed after the ZLB was reached due to changes in stocks’ sensitivity to investor sentiment. However, it is still the short leg stocks that are more affected by the path surprises. The stronger response of the short leg implies that the stocks which are more exposed to investor sentiment are also more sensitive to monetary policy shocks. Finally in Chapter 3 we examine how investor sentiment states affect the stock price drift before the scheduled FOMC announcements. We find that the returns on the S&P500 index increase significantly over the pre-FOMC window only during periods of high sentiment. We also find that investors allocate assets from low risk short-term T-bills to stocks on the pre- FOMC window during periods of high sentiment. Our findings on the pre-FOMC announcement order imbalance show that there are more buyer-initiated trade than seller-initiated trade on the S&P500 constituents during periods of high sentiment. These findings provide a behavioural explanation to the pre-FOMC announcement puzzle

The Reaction of Stock Returns to News About Fundamentals

In good times, stock prices react negatively to good news and positively to bad news, whereas in bad times, they react positively to good news and negatively to bad news. To account for this stylized fact, we consider an asset pricing model where the dividend growth rate switches between different values depending on the underlying state of the economy. Investors never observe the true dividend growth rate, but learn about it through not only its realizations but also external signals such as macroeconomic indicators. Under plausible assumptions, the differing precision of external signals across different states of the economy can change the sign of the market reaction to news from external signals in good and bad times. This paper was accepted by Brad Barber, finance. </jats:p