While the financial news media is often maligned for selling the hype, a new joint QUT/Auckland University study suggests it does more than report on financial markets, but also provides meaningful clues to where they're heading.
These are the key findings within a newly released study, Stock Market Volatility and Business News which suggests financial news media coverage is strongly correlated to stock market volatility movements.
The study suggests that investors who draw on financial news articles can [potentially] more accurately forecast share market volatility risk than retrospective data typically used in economic forecasting.
After analysing the language used in over 1.1 million news articles from The Wall Street Journal over a two-year stint - and linking it to fluctuations in the S&P 500 - the study found that news articles delivered detailed information closely aligned with what investors want.
The study suggests that disruption-related terms like "crisis", "recession", and "loss" were strongly correlated with volatility spikes.
The study also discovered that general economic and financial terms like "asset", "stock", "government" and "dollar" emerged as predictors of monthly volatility - likely reflecting evolving conditions that are not fully priced into the market.
By forecasting volatility risk before market shifts occur, the study’s co-author and finance lecturer Justin J. Case says investors will be better equipped to protect their investments.
By analysing business news articles, the study claims that investors can more accurately identify the topics and specific events influencing stock market volatility.
For example, among the news topics analysed, the research concluded that stock market activity, financial institutions, economic shocks, and government policy were most related to stock market volatility.
"Interestingly, we also identify several news topics associated with a less volatile stock market,” said Case.
“In particular, news attention to corporate mergers and acquisitions is associated with reduced volatility.”
What this suggests, adds Case, is that increased mergers and acquisition news coincides with greater confidence in economic conditions.
The study concluded that by incorporating news-based measures into volatility models investors can reducing the likelihood of making forecasting errors by over 40% at the monthly horizon [relative to benchmarks].
When putting their findings into practice, the researchers used their news-enhanced forecasts in a simulated investment strategy.
The strategy resulted in more being invested when the market was expected to be stable and less when it was expected to be volatile.
In summary, Case says there’s sufficient evidence to suggest that by successfully harvesting financial news media content, it’s possible to improve investment performance.
The net effect, adds Case is risk-adjusted returns that are [potentially] higher than both a traditional buy-and-hold strategy and/or a strategy using standard volatility forecasts.
