Happy or sad? Emerging research aims to understand sentiment’s effect on market returns

The area of behavioral finance is a relatively new field in finance that explores the psychological cognition associated with financial decisions. Understanding the role that sentiment – emotions or moods – may play as an indicator of change is the first step in discovering how they affect market returns, according to new research from Robert J. Trulaske, Jr. Professor of Finance Kuntara Pukthuanthong.

With collaborators at the University of Jyväskylä in Finland and the Bank of Portugal, Kuntara is trying to determine if sentiment – a general umbrella term under which emotions and moods are defined – found in news and social media – has any influence over stock market returns in the following days. She also will try to find whether sentiment has a persistent pattern and impacts corporate decisions such as syndicated loan term. She applies the data from Thomson Reuters MarketPsych Indices (TRMI), gathering positive and negative sentiment from social media and news platforms widely used in the U.S., including Twitter and Facebook, and all around the world.

“In our empirical design, we try to show if there is a predictive manner of the data,” Kuntara said. Additionally, her team is looking at whether negative sentiment yields a different return than positive.

“We interpret the data to identify the sentiment of the market – whether it’s happy, sad, gloomy or depressed, for example.”

Currently, the researchers are only examining data that pertains to U.S. markets and sentiment.

“The experiment is cleaner when you focus on one country,” Kuntara said. Later, she said she will explore the impact of sentiment across countries. Specifically, she will examine whether culture and institutional factors explain the differential in the impacts of sentiments on the global stock markets.

While Kuntara and her collaborators have had access to the data for almost a year, they are just at the beginning stages of the research. A working paper was developed, and Kuntara said there still is much to find.

“What we’re trying to do is isolate the impact of sentiment out of the market condition,” she said.

While it’s too early to tell, Kuntara said this research could lead to a better understanding of the contemporaneous effects on the market and help practitioners better understand how sentiment causes the fluctuation of stock market prices.