Sentiment during recessionsa discussion

byPatrick J. Kelly

New Economic SchoolAt the

The First International Moscow Finance Conference

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Summary

• Over a 101 year sample from 1905 to 2005:– When there is a 6 word difference between the

number of negative and positive words in the typical article returns are 5.5 basis points lower across all periods.

• These effects are most pronounced during recessions– 11.7 basis points in recessions, but only– 3.5 basis points in expansions

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Summary 2

• Some of the higher or lower returns partially revert– Especially following positive news.

• The reversion suggests the possibility this reaction to news articles is due to investor sentiment, not a rational reaction to value-relevant news content in the news.

• These findings are robust to– Alternate volatility specifications (GARCH)– Outliers– Predictability of the news– Except that predictability is muted if you focus

only on post open intra-day return.

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Comment 1: Technical and Economic Meaning

• The way the measures are developed one article can have both positive and negative words.– This ought to bias against you finding anything –

BUT the pessimism measure is clear, because you classify the entire article as more (or less) negative.

• Important - these effects are economically small. – 11 or 12 basis points of extra return on a

portfolio with a standard deviation of over 100 basis points.

– Spreads are a minimum of 6.25 to 12.5 basis points for most of this period.

• Suggestion: focus on Pessimism not positive and negative

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Comments: Sentiment?

• The main argument that this is a sentiment story is grounded in:1. That returns following news are larger during

recessions than expansions• Alternative hypothesis?• If they were the same for expansions and recessions,

does this mean that there is no sentiment story?

2. Reversion of the returns following lags of pessimistic articles• See Table 4

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Reversion Returns Following News

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Evidence for Sentiment through Reversion

• The evidence for sentiment is weak. – Anxiety may effect trading behavior, but a lot

more evidence is needed.

– Any day when the market is down – traders are going to be edgy.

– If the anxiety story is correct, news should be more important following large negative returns than positive.

• Suggestion: Consider interacting news and the coefficients on returns.

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A sentiment story?

• Not against a sentiment story – it just needs to be really well documented. For example:– Kim and Meschke (2011) look at the impact of

CEO interviews on CNBC and find evidence of an effect of sentiment• Document a lack of information• The behavior of individual investors and short sellers• And eliminate dates with any kind of confounding

event.

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Your evidence is also consistent with rational stories

• Henkel, Martin and Nardari (JFE, 2011) find the stock return predictability is strongest during recessions– They propose that the reason for this greater

predictability is due to • the difficult of valuing growth options – important

during expansions• The importance of cash/dividends (and financing

constraints) during recessions

• Your findings are eerily similar….– Perhaps the news these columns identify is

more important during recessions, • perhaps it is more tangible (about cash, not growth

options)

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Does the NYT identify important information?

• Chan (JF, 2003) finds that extreme price moves – revert if there is no news– Persist if there is news

• Perhaps this is what you are finding in your sample:– reporters do not generate news unknown to

the markets, – they filter and identify news that is relevant

to the markets.

• Suggestion: Allow the coefficients on lagged returns to interact with your indicator for news.– This could strengthen your results and/or

clarify the source of your findings.

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Separating Sentiment from Rational Stories in Recession

• Identify periods when sentiment is low but the market is actually in an expansion.– That way we can distinguish the more rational

stories suggested by Henkel, Martin, Nardari (2011) from the sentiment based you suggest.

• On the following slide consider the NBER recessions as compared to the Michigan Consumer Sentiment Survey from 1978.– Expansions do not always coincide with good

investor sentiment.

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Survey of Consumer Sentiment and NBER recessions