1

Media Reinforcement in International Financial MarketsKen Froot, HBS

Xiaoxia Lou, University of Delaware

Gideon Ozik, EDHEC Business School

Ronnie Sadka, Boston College

Siyi Shen, Boston College

March 2018

2

Research Question

Media

–An avenue through which information is gathered, processed, and disseminated

–Large amount of data are generated by media daily

Academic research has focused on direct effects

–Media coverage can predict returns

–Mainly focused on individual stocks and US aggregate equity

This work studies the interaction of media and asset prices

–Individual stocks

–Aggregate equity markets

–Currencies

3

How Does the Media Interact with Asset Prices?

How to measure optimism / pessimism?

– Asset prices is one indicator

– Look at media sentiment!

This work advances a simple concept:

When return and sentiment reinforce one another

– There is unusually high optimism, which results with overreaction

Abnormal return

Expected reversal w/o media

Expected reversal with media

4

• The role and content of media and its impact on asset prices:

–e.g., Tetlock (2007), Tetlock, Saar-Tsechansky, and Macskassy (2008), and Chen, De, Hu, and Hwang (2014)

• Short-term return autocorrelation:

–e.g, Jegadeesh (1990), Lehman (1990), Jegadeesh and Titman (1995), Copper (1999), and Avramov, Chordia, and Goyal (2006)

• Information dissemination in financial market:

–e.g., Chan (2003), Tetlock (2010), and Griffin, Hirschey, and Kelly (2011)

• Investor behavioral biases:

–e.g., Daniel, Hirshleifer, and Subrahmanyam (1998), Barber and Odean(2008), and Solomon, Soltes, and Sosyura (2014)

Related Literature

5

The Power of the Media

GeneralMedia

SpecializedMedia

Corporate Communications

SocialMedia

• What is the world saying?

• What is the industry saying?

• What are companies

saying?

• What are peoplesaying?

• Wealth of information

• A careful examination of the data and the correction for various effects

6

The Data

12 developed market currency: AUD, CAD, CHF, DKK, EUR, GBP, ILS, JPY, NOK, NZD, SEK, SGD

+2 developed market equity: HKD, USD

17 emerging markets: ARS, BRL, CLP, CNY, COP, EGP, IDR, INR, MXN, MYR, NGN, PHP,PLN, RUB, THB, TRY, ZAR

• FX and Equity indices

• Currencies

• Equity indices

Countries

MediaCoverage

Other AssetClasses

Sentiment Scoring

• Textual analysis

• Large-cap stocks

• Commodities

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The Data – Cont’d

Zoom

coun

t

NonSP500 NonUS SP500

Jan '16 Jul '16 Jan '17 Jul '17

0k

50k

100k

Number of articles covering firms Number of articles by country of source (FX, Country)

FX / Country articles by source typeFX / Country articles by year

- 30,000 60,000 90,000 120,000 150,000Russia

SingaporeSwitzerland

New ZealandBrazil

ThailandMalaysia

South AfricaMexico

AustraliaHong Kong

CanadaChinaJapan

IndiaUK

Euro ZoneUSA

8

Brexit Vote (June 23, 2016)1-day abnormal country equity sentiment

• Prior to Brexit vote, sentiment seemed mostly positive

• Once ‘Leave’ was announced, global sentiment turned sharply negative, with UK, European countries, the Americas and Australia leading the way

• In contrast, Russia and China exhibit a positive sentiment shock

9

US Presidential Election (Nov 8, 2016)1-day abnormal FX sentiment

• The extent of the results became clear only after midnight ET. Therefore, media on 11/8/2016 does not reflects the surprising results whereas media coverage on 11/9/2016 reflect the full extent of the results

• While world sentiment turned negative overall, a few countries displayed positive sentiment, notably, Russia and Turkey

10

French Presidential Election (April 23, 2017)1-day abnormal country equity sentiment

• The results of the first round indicated strong performance of Emmanuel Macron, the center-leaning candidate, alleviating concerns of anti-European pressures

• Other than a few exceptions (e.g., Portugal, Poland), country equity sentiment reacted positively

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Tests using Portfolio Returns

• First examine the relative autocorrelation in the different markets

• Form 10-day-ladder portfolios based on past weekly returns

• Then, add past weekly media sentiment

• Sample: March 2013 – April 2017

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Media Reinforcement – Portfolio Sorts

10-day-ladder portfolios sorted by past weekly return and sentiment

ReturnsMedia FX Developed1 Country Equity2 Large Stocks3

Returns Low Return

High Return

LowReturn

HighReturn

LowReturn

HighReturn

Med

ia

Low Sentiment

+2.04%[1.94]

-1.15%[-1.33]

+2.12%[1.78]

0.57%[0.44]

+2.25%[2.01]

-1.02%[-1.03]

High Sentiment

+0.83%[0.91]

-1.72%[-1.92]

+0.31%[0.27]

-3.01%[-2.57]

+1.09%[1.00]

-2.32%[-2.07]

Reversal -2.90%[-1.91]

-2.53%[-1.56]

-3.34%[-1.75]

Reinforcement -3.76%[-2.10]

-5.11%[-2.49]

-4.57%[-2.09]

1 Sentiment measured from FX media;2 Sentiment measured from FX media;3 Sentiment measured from stock equity media

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Portfolios in event time: Stocks

Reinforcement effect

• High return and high sentiment leads to low return

• Low return and low sentiment leads to high return

low sentiment

high sentiment

low sentiment

high sentiment

High ReturnLow Return

-0.01%

0.01%

0.03%

0.05%

0.07%

0.09%

-2.50%

-2.00%

-1.50%

-1.00%

-0.50%

0.00%

-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10Days

-0.09%

-0.07%

-0.05%

-0.03%

-0.01%

0.01%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10Days

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• Decomposition of Expected and Unexpected return and sentiment:

• In-sample estimation, per asset

• Expected components explain a small fraction of total variance:Average R2 ranges between 1.23% to 2.37%

Reinforcement or Feedback? Empirical Design

, , , , , ,

, , , , , ,

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Portfolio Sorts – Expected Components

10-day-ladder portfolios sorted by past weekly expected return and sentiment

ReturnsMedia FX Developed Country Equity Large Stocks

Returns Low Return

High Return

LowReturn

HighReturn

LowReturn

HighReturn

Med

ia

Low Sentiment

-2.06%[-2.70]

1.29%[1.51]

-1.99%[-1.67]

3.96%[2.78]

-4.84%[-3.56]

5.07%[4.93]

High Sentiment

-0.24%[-0.27]

1.01%[1.31]

-2.45%[-2.30]

0.48%[0.43]

-5.16%[-5.80]

4.93%[5.50]

Reversal 2.09%[1.89]

4.34%[2.61]

9.99%[6.20]

Reinforcement 3.06%[2.38]

2.47%[1.20]

9.76%[4.52]

The expected components generate continuation; no reinforcement effect

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Portfolio Sorts – Unexpected Components

10-day-ladder portfolios sorted by past weekly unexpected return and sentiment

ReturnsMedia FX Developed Country Equity Large Stocks

Returns Low Return

High Return

LowReturn

HighReturn

LowReturn

HighReturn

Med

ia

Low Sentiment

2.03%[1.92]

-0.38%[-0.39]

3.14%[2.64]

-0.36%[-0.29]

2.47%[2.30]

-2.13%[-1.96]

High Sentiment

0.69%[0.72]

-2.34%[-2.79]

0.75%[0.64]

-3.54%[-3.25]

1.89%[1.63]

-2.23%[-2.02]

Reversal -2.76%[-1.97]

-3.99%[-2.51]

-4.35%[-2.23]

Reinforcement -4.37%[-2.55]

-6.69%[-3.35]

-4.70%[-2.23]

The unexpected components generate reversal;The results are consistent with reinforcement rather than feedback

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Macroeconomic News and Earnings Announcements

Construct portfolios excluding news dates in formation period

ReturnsMedia FX Developed Country Equity Large Stocks

Returns Low Return

High Return

LowReturn

HighReturn

LowReturn

HighReturn

Med

ia

Low Sentiment

+1.92%[2.01]

-0.64%[-0.74]

+2.34%[1.58]

-0.21%[-0.14]

+2.63%[2.39]

-0.87%[-0.84]

High Sentiment

+019%[0.19]

-1.48%[-1.66]

+0.93%[0.67]

-3.06%[-2.18]

+1.00%[0.94]

-2.76%[-2.45]

Reversal -2.17%[-1.57]

-3.26%[-1.70]

-3.63%[-1.88]

Reinforcement -3.40%[-2.04]

-5.40%[-2.13]

-5.39%[-2.48]

The results are not due to main information events

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Additional Analyses

• Including additional sources for FX and Country equity

• Alternative measures of sentiment

• Cross-sectional regressions using quartile dummies

• Different types of media

Strong in local media

• Effect is stronger for large caps, highly covered by the media

• Calculation of risk-adjusted returns (per asset class)

• Emerging markets and Commodities

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0.00%

0.02%

0.04%

0.06%

0.08%

0.10%

0.12%

0 1 2 3 4 5 6 7 8 9 10Day

‐0.08%

‐0.07%

‐0.06%

‐0.05%

‐0.04%

‐0.03%

‐0.02%

‐0.01%

0.00%

0 1 2 3 4 5 6 7 8 9 10

Day

High Coverage

Low Coverage

Low Coverage

High Coverage

High Sentiment + High Return Low Sentiment + Low Return

Relation to Intensity of Media Coverage

• Higher media coverage intensifies reinforcement

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-0.02%

0.00%

0.02%

0.04%

0.06%

0.08%

0.10%

0 1 2 3 4 5 6 7 8 9 10Day

-0.10%

-0.08%

-0.06%

-0.04%

-0.02%

0.00%

0.02%

0 1 2 3 4 5 6 7 8 9 10Day

Large

Small

Small

Large

High Sentiment + High Return Low Sentiment + Low Return

• Reinforcement effect more prominent in large caps

• Liquid firms attract more investors

Relation to Liquidity: Individual Stocks

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What happens When You Combine All of These?

Strategy

• Construct the 2 x 2 return/sentiment portfolios

• Weekly formation period, skip one day, 10-day ladder

• Long: low return low sentimentShort: high return high sentiment

• Start day: 3/1/2013, End day: 4/27/2017

Performance• Examine FX (developed), Country equity (all), and firm equity (large caps) separately

• Combine all (volatility weighted)

0.901.00

1.101.201.30

Combined; IR = 1.75

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Summary and Conclusion

• Media is a fruitful avenue for research

• Reinforcement effect in financial markets

• Robust results