IMF Research Perspectives is the new online newsletter covering updates on IMF research.

Abstract

IMF Research Perspectives is the new online newsletter covering updates on IMF research.

How do investors react to news? It’s no surprise that this question has been at the core of the financial research agenda for several decades. But two forces have made this question even more pressing. On the one hand, innovations in information technologies have dramatically increased the reach of financial and economic news and the speed at which it travels. Real-time news wires, such as Reuters and Bloomberg, generate and diffuse information almost instantaneously and to an ever-increasing set of market participants. On the other hand, a growing number of countries, especially those whose markets are emerging, have opened their financial markets to the rest of the world. Among other things, this means that foreign news can affect local market conditions much more directly than in the past.

For a long time, however, studying the impact of news on investors’ behavior and asset prices remained a daunting task. What is news exactly? What does it talk about? And how can we identify, in a systematic way, good (or bad) news? Fortunately, the past decade ushered in major advances in natural language processing, a field that mines and analyzes large amounts of textual information to extract its key features, such as topic and tone.

Since then, successful examples of text mining in economics and finance-using both traditional news sources and social media content-have flourished. Building on the most recent technologies, an IMF research project assessed the role of news in international asset prices using more than 4 million articles published by Reuters across the globe between 1991 and 2015. Using text-mining techniques to capture the tonality of news content, the project first constructed a daily “news-based” sentiment index for both advanced and emerging markets. Then it asked whether optimism (or pessimism) in the news today could help predict changes in asset prices.

The study first shows that sudden changes in news sentiment had a significant impact on asset prices around the world, confirming that media tone, in general, is a very good proxy for investor sentiment. It also highlights the role of foreign news (and foreign investors) rather than local news (and local investors) in driving local asset prices. Although sudden optimism in global news sentiment generates a strong and permanent impact on asset prices around the world, the effect of optimism in local news was more muted and only temporary (See Figure 1).

Figure 1.
Figure 1.

Media Tone and Asset Prices

Citation: IMF Research Bulletin 2019, 001; 10.5089/9781498320177.026.A004

Source: Fraiberger, S.P., D.Lee, D. Puy and R. Ranciere, 2018. “Media Sentiment and International Asset Prices,” IMF Working Paper 1 8/274.Note: The figure plots the response of equity prices around the world to optimism in global news (green) and local news (blue).

From a technical perspective, the study offers another example of the power of text as an input for cutting-edge economic and financial research.

Importantly, the study also illustrates how new technologies-such as big data and text mining-can help institutions in their daily work. For instance, the mood captured in the news published around the world every day-the so-called global news sentiment index-mirrors other popular measures of global risk aversion, such as the Chicago Board Options Exchange Volatility Index (VIX; Figure 2). However, the news-based index is ultimately a better predictor of future movements in international asset prices than the VIX. “We are still in the process of understanding why news sentiment matters so much, and why it seems to capture much more information about investors’ mood than other market-based indicators that are widely used. But the project already shows that monitoring news tone in real time is a very effective way to capture sudden changes in investor sentiment that would not be captured otherwise; which is key for financial surveillance” says Samuel Fraiberger, one of the coauthors of the study.

Figure 2.
Figure 2.

Global Risk Aversion (VIX) versus Media Sentiment

Citation: IMF Research Bulletin 2019, 001; 10.5089/9781498320177.026.A004

Source: Fraiberger, S.P., D.Lee, D. Puy and R. Ranciere, 2018. “Media Sentiment and International Asset Prices,” IMF Working Paper 18/274.Note: VIX = Chicago Board Options Exchange Volatility Index.
IMF Research Perspectives: Spring-Summer 2019
Editor: Ms. Yuko Hashimoto