Blog Feature

Trading on the News to Predict Market Behavior

Image of Trading on the News to Predict Market Behavior

Associate Professor Anna Scherbina studies investment management, capital markets, behavioral finance, and empirical asset pricing. In this blog, she discusses practical implications for her recent research regarding trading on the news.

It shouldn’t be surprising to anyone that news affects stock market prices. A company comes out with a new product, announces expansion into new markets, or reports financial losses for a certain quarter. This kind of information undoubtedly affects the way investors trade, but to what extent?  My latest study, co-authored with Andreas Neuhierl and Bernd Schlusche, “Market Reaction to Corporate Press Releases” explores this very issue. Our findings can provide investors a leg up in the market by providing more insight on how to interpret market behavior and invest more wisely.

Recently, a regulation was passed mandating that corporations publically release all news that might affect their valuation, which is what corporations now do, typically in the form of corporate press releases. This is great news for investors in general. Why? Because prior to this regulation corporations were only required to release news to financial managers and investment analysts, not to everyone. For the first time, the public has unprecedented access to news that could provide insight into market reactions in real time.

My co-authors and I took advantage of this situation by collecting and categorizing the news releases, keeping an eye on content that affected investment value.

Of course, the key thing to examine is the immediate price reaction.  Knowing the history of price reaction to specific types of news, investors can improve their ability to predict market reaction and trade more effectively on the news.

Yet some news may be ambiguous and not lead to an immediate price reaction.  High trading volume following an announcement may indicate that investors disagree about the impact of the news. High level of investor uncertainty about the resulting valuation will lead to low liquidity, because traders will be concerned that someone else knows more about the stock price than they do.  Hence, it is also crucial to study the impact of news on the informational environment of the firm. When informational uncertainty increases, price becomes tenuous, and thus reacts more strongly to subsequent news releases, increasing subsequent price volatility.  Hence, investigating changes in trading volume, liquidity and volatility subsequent to news releases offers another important angle in exploring the impact of news announcements.

Our findings confirmed earlier studies about what the price reaction should be for different types of news, and identified price reactions to the types of news that previously received little attention due to lack of data.  We also confirmed that some news have the potential to significantly alter the information environment of the firm.  In particular, we confirmed that news stories using keywords like “groundbreaking” or “unprecedented” signaled to investors that the content was out of the ordinary, and typically led to significant increases in subsequent stock volatility. In short, the market knows how to react to routine news, but has difficulty interpreting the impact of less routine news.

Takeaways for Investment Professionals

Investment professionals can potentially trade on the news, but it’s not easy because they have to apply a strategy of quick turnover. The reason for this is that the price reaction to news releases is very quick so they need to stay on their toes. One way to manage the process is to create an algorithm where investors scan various newswires, pull out press releases and identify content based on keywords. However, it might be difficult to  identify whether news is positive or negative by using standard linguistic analysis, because more often than not, bad news is framed in a positive way.

For example, there’s now a new set of linguistics applied to news where companies such as Reuters or Dow Jones try to classify news based on content analysis. These news agencies identify negative and positive keywords to interpret the content. However, the cautionary note is that this approach can be misleading. One great example is that sometimes when a corporation’s stock is overpriced, the company will issue equity, to take advantage of the overvaluation. To an outsider, it’s not apparent that something’s wrong because the press release doesn’t contain negative keywords.  This kind of behavior signals that the stock might be overpriced. So what works for investors?  In order to get more precise news classifications, they would have to analyze the content of the news, in addition to how it is being presented.

UC Davis Executive Education highlights the research of key faculty members in the Graduate School of Management, interpreting their findings and teasing out the practical takeaways for leaders and professionals. For more information on Executive Education at UC Davis, please contact Managing Director Wendy Beecham.

Comments

Post new comment

744489275900 » If you have a visual disability, please type the numbers two one three three into the box. Your submission will be promptly reviewed by a validation service and sent to the site administrators.
By proving you are not a machine, you help us prevent spam and keep the site secure.

Commands

Twitter Feed

Loading tweets...

News Release

UC Davis Part-Time MBA Ranked in Nation’s Top 9%
Fourth Consecutive Year among U.S News & World Report's Premier Programs

Image of UC Davis Part-Time MBA Ranked in Nation’s Top 9%

(Davis, CA) — The UC Davis Part-Time MBA program offered in Sacramento and the San Francisco Bay Area is ranked among the top 9% in the U.S., according to U.S. News & World Report’s latest graduate business school rankings.

At No. 29, this is the fourth consecutive year the UC Davis Part-Time MBA program is among the top AACSB International-accredited part-time MBA programs surveyed. This year, there were 323 part-time MBA programs surveyed.

News Release

UC Davis Full-Time MBA Ranked among Nation’s Premier Programs for 20th Consecutive Year
MBA Programs among Top 10% in U.S.
Record Salary and Bonus

Image of UC Davis Full-Time MBA Ranked among Nation’s Premier Programs for 20th Consecutive Year

(Davis, CA) — The UC Davis Graduate School of Management’s Full-Time MBA program is ranked among the premier business schools in the nation for the 20th consecutive year, according to U.S. News & World Report’s latest graduate business school rankings released today.

U.S. News’ latest ranking places the Full-Time MBA program at No. 48, placing it among the top 10% of the 464 Association to Advance Collegiate Schools of Business International’s accredited full-time MBA programs surveyed.

Key statistics from the School’s Full-Time MBA ranking include:

News Release

UC Davis Graduate School of Management partners with Lawrence Livermore and Sandia National Labs to drive technologies from lab to market

Image of UC Davis Graduate School of Management partners with Lawrence Livermore and Sandia National Labs to drive technologies from lab to market

(Davis, Calif.) – With a joint goal of speeding the transfer of new technologies from the laboratory to the commercial marketplace, the UC Davis Graduate School of Management, Lawrence Livermore National Laboratory and Sandia National Laboratories have announced a new partnership for researchers to develop their entrepreneurial skills.

Spotlight Story

Vickie Sherman MBA 13 Finds Her Passion, Her Career—and Herself

Image of Vickie Sherman MBA 13 Finds Her Passion, Her Career—and Herself

What opportunities, decisions, events have shaped your professional life?

My career path has been a climb across a jungle gym rather than a tangent up a corporate ladder. As a child, I used to thumb through the three-inch JCPenney catalogue, picking out the professional women who I would grow to be. I wanted to rule the world from a corner office in a suit and heels. I wanted to shed my humble origins and become Corporate Barbie.

Spotlight Story

MBA Student Consultants Make an IMPACT
Projects Put Business Needs Front and Center

Image of MBA Student Consultants Make an IMPACT

Agilent Technologies’ Electronic Measurement Group is a $3.6 billion business that over the past decade has seen a dramatic shift in its customer base from U.S., and Western European customers to predominantly Asia-based customers. Today, the majority of the division’s revenues are generated outside of the U.S., with an increasing concentration in China.