Sometimes, the news is just too gloomy.
Paul Tetlock, assistant professor of finance at the School of Management's International Center for Finance at Yale University, New Haven, studied the wording found in 3,700 daily market columns published in the Wall Street Journal from January 1984 to mid-September 1999, with the help of quantitative content analysis software.
In his paper, Giving Content to Investor Sentiment: The Role of Media in the Stock Market, Mr. Tetlock asks whether the media's wording reflects prevalent pessimism or contains new information that could lead portfolio managers to rethink their allocation.
Mr. Tetlock found that pessimistic news reports indicated downward market movements in the short term, followed by a return to fundamentals. Those news reports added noise to stock prices, and thus could signal that managers might want to hold off some trades for a day.
Switching between long and short positions on the market based solely on the content of the market column is probably not a good idea because the transaction costs involved in this high-frequency trading strategy would probably outweigh the potential profits. However, if an asset manager had originally planned to increase her stock holdings on a day in which a particularly gloomy column appears, she may benefit by postponing her purchase one day. Conversely, a manager initially planning on selling some of her stock holdings may want to wait one day if there is a particularly rosy column, Mr. Tetlock said.
The paper, published in the American Finance Association's Journal of Finance in June 2007, won the Smith Breeden First Prize last year.
Paul's paper is extremely innovative. He's looking at the media, the Wall Street Journal column, and then using scientific techniques developed in other fields to see if a given sentiment in the market can predict what happens in the future, said Campbell Harvey, principal at Smith Breeden Associates Inc., Chapel Hill, N.C., which has $32 billion in assets under management and is the firm that offers the prize.
Paul is using highly quantitative programs to harvest this information. It's a style that we are going to see more of, added Mr. Harvey, who also is the editor of the Journal of Finance and is on leave of absence as professor of international business at Duke University's Fuqua School of Business, Durham, NC.Isabelle Clary