Impact of News Sentiment on (Intra-day) Abnormal Stock Return

Recently, I conducted a study on the impact of news sentiment on abnormal stock returns with the objective to identify certain event categories that could be traded profitably. The study was based on a portfolio of large cap stocks covering the Dow Jones Industrial Average and the Eurostoxx50 for the years 2005 through 2008. My research focused on intra-day trading, assuming a maximum holding period of five hours (or until market close). Based on a set of sentiment classifiers used to process textual news stories (data supplied by RavenPack), I constructed a set of 63 event categories characterized by unique combinations of sentiment classiffications. Of these, I found that at least 39 categories showed interesting results in terms of creating trading signals. Of all sentiment-based events, 87% showed positive average Information Ratios (IR) amounting to 90,000 events over the four year period with about 50% translating into short signals. On average, the most profitable short trading signals generated 0.70% per trade before transaction costs in the five hours following the event, this with Hit Ratios in the range of 60-65%, see figure below.

The key findings of the Intra-day Abnormal Return study can be summarized as:

• 39 of 63 event categories show positive average Information ratios measured over the five hour post-event window.
• 87% of all sentiment-based events show positive average Information ratios amounting to 90,000 events over the four year period.
• 50% of the identified events translate into short signals, while the remaning events are considered long signals.
• The Top 10 and Top 20 event categories generate about 550 and 6,500 signals over the four year period, respectively.
• 62% of the 39 event categories hold positive average Information ratios in at least three of the four years covered in the study.
• On average, the most profitable short trading signals yielded 0.70% per trade with Hit Ratios in the range of 60-65% (Fig. 2).
• On average, the most profitable long trading signals yielded 0.40% per trade with Hit Ratios in the range of 40-70% (Fig. 4).
  

The most successful long strategy yielded about 0.40% per trade, with a Hit Ratio in the range of 40-70%, see below figure. In total, the “Top 10” and “Top 20” event categories generated about 550 and 6,500 trading signals over the relevant period, respectively.

To consider the consistency of the trading signals, I conducted a year-by-year analysis and found that 62% of the interesting event categories held positive average Information Ratios in at least three of the four years covered in the study.

I think the above findings indicate that News Sentiment could potentially be applied profitably as a factor or an overlay to a trading model, and thus add value in the alpha-generation process at an intra-day level. The full results of my findings are documented in Hafez, Peter. Impact of News Sentiment on Abnormal Returns (May 15, 2009). In the near future, I plan to present a series of interesting results found by Macquarie Equity Research applying news sentiment in more traditional low frequency investment strategies.