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The event study was conducted on the constituents of the Russell 3000 index covering both large and small cap companies for the period January 2005 through March 2009 with sentiment data supplied by RavenPack. As part of the study, Macquarie focused purely on high relevance events (Relevance=100 out of 100). In total, just below 53,000 events were identified during the four year period with about 30% translating into short signals and 70% into long signals (as represented by negative and positive sentiment respectively). An event was defined as a news story with at least three of five classifiers holding positive (negative) sentiment, and with the remaining classifiers being neutral. As part of the event study, a pre- and post event window of sixty days were applied.
The key findings of the Macquarie event study can be summarized as:
- Investors are more likely to react adversely to negative news sentiment than to react favorably to positive news sentiment.
- Investors appear to be more aggressive and impulsive on sell decisions and more conservative or tentative on buy decisions.
- Negative news sentiment is a stronger leading indicator of future underperformance than positive sentiment is for future outperformance.
- Investor reaction to neutral news stories is slightly negative, although this may be clouded by the fact that a deep bear market makes up a significant proportion of the sample period. They find that in bear markets, investors’ reaction to the same piece of news is much more negative.
- Investors’ perception of a news event changes depending on market conditions
- Stocks tend to be underperforming prior to a negative news announcement. Macquarie suggests two potential reasons: (1) this may be because companies are reluctant to release bad news until they absolutely have to, so typically the market has already anticipated the bad news before it is finally released. (2) could reflect the fact that news sentiment is somewhat auto-correlated, meaning bad news is more likely to be followed by more bad news, so stocks that experience one negative news event are likely to have already had previous negative events in the past.
- When bad news is released, the price impact is immediate. The key question for low frequency investors is whether there is any post-event price drift, because this will determine the potential profit opportunity from reacting to bad news. The Macquarie results suggest that stocks continue to drift downwards for the next five days, which is a promising sign for investors.
- Stocks tend to rebound after about five days. This rebound may be due to the fact that investors initially overreact to negative news. The old adage that investors sell first and ask questions later when faced with bad news seems to apply. The rebound could also be due to short covering as investors who shorted the stock lock-in profits.
- But after the bounce, securities tend to reverse and underperform for one to three months after a significant negative news announcement. This finding is noteworthy because it suggests that news sentiment does have predictive power in forecasting future underperformance (although the key question here is whether news sentiment adds anything beyond traditional quant factors – will be addressed in the next blog posting).
- Securities tend to outperform slightly prior to the release of a positive news event. This is similar to the reaction of securities around the time of negative news events, where securities underperform prior to the announcement date.
- On the news release date, securities tend to outperform. The extent of the outperformance for positive new events is less than the corresponding underperformance for a negative event. This may suggest that investors are more likely to react adversely to negative news sentiment than react favorably to positive news sentiment. Macquarie highlights that they suspect the presence of a behavioral bias at the root of this asymmetry – as they saw a similar result when studying the market reaction to analyst earnings revisions.
- There is no short-term reversal after positive news events. Unlike negative news events, investors do not appear to overreact to positive news. Instead, stocks with positive news continue to drift up slowly relative to the market. One explanation for this could be that investors are more willing to wait and take their time digesting positive news before buying in, whereas they just want to get out as quickly as possible when selling after bad news.
- Securities tend to outperform only slightly one to three months after a positive news announcement. In other words, the day +1 to day +60 return for positive news events is much more muted than that for negative news events. This suggests that negative news sentiment may be a stronger leading indicator of future returns than positive news sentiment.