Media matters for asset price volatility

The media narrative is a powerful influence on the price of financial assets. Positive news not already built into investor expectations tends to result in higher prices, and vice versa for unexpectedly negative news. Often the bigger the surprise, the larger the jump in volatility.

The narrative of any story is constructed from three basic building blocks: sentiment (whether a story is positive or negative), attention (the volume of the narrative) and cohesion (the consistency and strength of the narratives foundations). Being able to follow the changing media narrative and interpreting it correctly could give an investor an edge in understanding future price action.

Attention may lead to higher volatility

Research published in the International Journal of Forecasting analysed the impact of two of these building blocks on stock market volatility: sentiment (the degree to which news articles/tweets were positive or negative) and attention (the volume of tweets/searches). Their study shows that both sentiment and attention variables have predictive power for future volatility even when controlling for a large set of economic and financial variables.

However, measures of investors’ attention were found to have the most significant impact on future volatility. More precisely, Google searches for financial keywords (e.g. ‘‘stock market’’) and the daily volumes of company specific messages posted on social media were positively correlated with higher price volatility. Importantly, these indicators only appeared to have any degree of predictive power over the course of a couple of days.

Media sentiment has an asymmetric impact on some commodity markets

Most research has tended to focus on the impact of media sentiment on equity markets, sectors and the value of individual shares. Very little research has focused on commodity futures prices. A recently published study by researchers at United Arab Emirates University investigated the effects of media sentiment on eight different commodities – aluminum, crude oil, gold, heating oil, natural gas, palladium, platinum and silver .

Media sentiment was gauged by using daily commodity specific investors sentiment indices, obtained from Thomson Reuters MarketPsych Indices (TRMI) covering the period between January 1998 and July 2018. The TRMI’s sentiment indices are derived from textual data from financial news and social media (i.e., includes more than 2 million news articles and posts every day) and broadly reflects market emotion for a specific commodity by investors, analysts, journalists, and economists, etc.

Unsurprisingly, they found that positive media sentiment carries through into a positive return for commodity prices, and vice versa for negative media sentiment. Where the results are particularly interesting is the impact of the media on volatility, and what this could mean for investors managing positions.

The study found that oil and natural gas show a negative and highly significant asymmetric relationship between sentiment and volatility. An increase in news sentiment resulted in lower volatility in oil and natural gas prices, and vice versa for negative sentiment. This implies that long-side investors need to factor in the potential for greater volatility in oil and gas markets, especially when positive news sentiment is stretched, and there is a risk of mean reversion towards negative media sentiment.

The fact that they didn’t find a strong relationship among the other commodities may suggest something fundamental about oil and gas which singles them out versus other commodities. The most likely one being the storage and logistical constraints involved with the supply of oil and natural gas.

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