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Twitter mood predicts the stock market.

Investor sentiment, defined broadly, is a belief about future cash flows and investment risks that is not justified by the facts at hand. The question is no longer whether investor sentiment affects stock prices, but how to measure investor sentiment and quantify its effects. One approach is "bottom up," using biases in individual investor psychology, such as overconfidence, representativeness, and conservatism, to explain how individual investors underreact or overreact to past returns or fundamentals. The investor sentiment approach that we develop in this paper is, by contrast, distinctly "top down" and macroeconomic: we take the origin of investor sentiment as exogenous and focus on its empirical effects. We show that it is quite possible to measure investor sentiment and that waves of sentiment have clearly discernible, important, and regular effects on individual firms and on the stock market as a whole. The top-down approach builds on the two broader and more irrefutable assumptions of behavioral finance -- sentiment and the limits to arbitrage -- to explain which stocks are likely to be most affected by sentiment. In particular, stocks that are difficult to arbitrage or to value are most affected by sentiment.

/pdf/investor-sentiment-in-the-stock-market-50cs28ylr8.pdf

Investor Sentiment in the Stock Market

A revolution in the science of emotion has emerged in recent decades, with the potential to create a paradigm shift in decision theories. The research reveals that emotions constitute potent, pervasive, predictable, sometimes harmful and sometimes beneficial drivers of decision making. Across different domains, important regularities appear in the mechanisms through which emotions influence judgments and choices. We organize and analyze what has been learned from the past 35 years of work on emotion and decision making. In so doing, we propose the emotion-imbued choice model, which accounts for inputs from traditional rational choice theory and from newer emotion research, synthesizing scientific models.

/pdf/emotion-and-decision-making-25g5wm23rq.pdf

Emotion and Decision Making

During the 2008-2009 financial crisis, firms with high social capital, measured as corporate social responsibility (CSR) intensity, had stock returns that were four to seven percentage points higher than firms with low social capital. High-CSR firms also experienced higher profitability, growth, and sales per employee relative to low-CSR firms, and they raised more debt. This evidence suggests that the trust between the firm and both its stakeholders and investors, built through investments in social capital, pays off when the overall level of trust in corporations and markets suffers a negative shock.

https://onlinelibrary.wiley.com/doi/pdf/10.1111/jofi.12505

Social Capital, Trust, and Firm Performance: The Value of Corporate Social Responsibility during the Financial Crisis

The research in Psychology and Economics (a.k.a. Behavioral Economics) suggests that individuals deviate from the standard model in three respects: (1) nonstandard prefer- ences, (2) nonstandard beliefs, and (3) nonstandard decision making. In this paper, I survey the empirical evidence from the field on these three classes of deviations. The evidence covers a number of applications, from consumption to finance, from crime to voting, from charitable giving to labor supply. In the class of nonstandard preferences, I discuss time preferences (self-control problems), risk preferences (reference depen- dence), and social preferences. On nonstandard beliefs, I present evidence on overcon- fidence, on the law of small numbers, and on projection bias. Regarding nonstandard decision making, I cover framing, limited attention, menu effects, persuasion and social pressure, and emotions. I also present evidence on how rational actors—firms, employers, CEOs, investors, and politicians—respond to the nonstandard behavior described in the survey. Finally, I briefly discuss under what conditions experience and market interactions limit the impact of the nonstandard features.

/pdf/psychology-and-economics-evidence-from-the-field-518as6novo.pdf

Psychology and Economics: Evidence from the Field

This paper analyzes the relationship between employee satisfaction and long-run stock returns. A value-weighted portfolio of the "100 Best Companies to Work For in America" earned an annual four-factor alpha of 3.5% from 1984-2009, and 2.1% above industry benchmarks. The results are robust to controls for firm characteristics, different weighting methodologies and the removal of outliers. The Best Companies also exhibited significantly more positive earnings surprises and announcement returns. These findings have three main implications. First, consistent with human capital-centered theories of the firm, employee satisfaction is positively correlated with shareholder returns and need not represent managerial slack. Second, the stock market does not fully value intangibles, even when independently verified by a highly public survey on large firms. Third, certain socially responsible investing ("SRI") screens may improve investment returns.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1448247_code393296.pdf?abstractid=985735&rulid=8649398&mirid=3

Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices

http://faculty.london.edu/aedmans/Rowe.pdf

This paper investigates the stock market reaction to sudden changes in investor mood. Motivated by psychological evidence of a strong link between soccer outcomes and mood, we use international soccer results as our primary mood variable. We find a significant market decline after soccer losses. For example, a loss in the World Cup elimination stage leads to a next-day abnormal stock return of −49 basis points. This loss effect is stronger in small stocks and in more important games, and is robust to methodological changes. We also document a loss effect after international cricket, rugby, and basketball games. THIS PAPER EMPLOYS A NOVEL MOOD VARIABLE, international soccer results, to investigate the effect of investor sentiment on asset prices. Using a cross-section of 39 countries, we find that losses in soccer matches have an economically and statistically significant negative effect on the losing country’s stock market. For example, elimination from a major international soccer tournament is associated with a next-day return on the national stock market index that is 38 basis points lower than average. We also document a loss effect after international cricket, rugby, and basketball games. On average, the effect is smaller in magnitude for these other sports than for soccer, but is still economically and statistically significant. We find no evidence of a corresponding effect after wins for any of the sports that we study. Controlling for the pre-game expected outcome, we are able to reject the hypothesis that the loss effect after soccer games is driven by economic factors such as reduced productivity or lost revenues. We

/pdf/sports-sentiment-and-stock-returns-53epvjnte4.pdf

Sports Sentiment and Stock Returns

This paper analyzes how blockholders can exert governance even if they cannot intervene in a firm's operations. Blockholders have strong incentives to monitor the firm's fundamental value, since they can sell their stakes upon negative information. By trading on private information (following the "Wall Street Rule"), they cause prices to reflect fundamental value rather than current earnings. This in turn encourages managers to invest for long-run growth rather than short-term profits. Contrary to the view that the U.S.'s liquid markets and transient shareholders exacerbate myopia, I show that they can encourage investment by impounding its effects into prices.

https://papers.ssrn.com/sol3/Delivery.cfm?abstractid=946669

Blockholder Trading, Market Efficiency, and Managerial Myopia

This paper analyzes how blockholders can exert governance even if they cannot intervene in a firm’s operations. Blockholders have strong incentives to monitor the firm’s fundamental value because they can sell their stakes upon negative information. By trading on private information (following the “Wall Street Rule”), they cause prices to reflect fundamental value rather than current earnings. This in turn encourages managers to invest for long-run growth rather than short-term profits. Contrary to the view that the U.S.’s liquid markets and transient shareholders exacerbate myopia, I show that they can encourage investment by impounding its effects into prices. The nature of competition has changed, placing a premium on investment in increasingly complex and intangible forms—the kinds of investment most penalized by the U.S. [capital allocation] system. —Porter (1992) THIS PAPER ANALYZES how outside blockholders can induce managers to undertake efficient real investment through their informed trading of the firm’s shares. By gathering information about a firm’s fundamental value and impounding it into prices, they encourage managers to undertake investment that increases long-run value even if it reduces interim profits. The model therefore addresses two broad issues. First, it introduces a potential solution to managerial myopia. Second, it demonstrates that shareholders can add significant value even if they cannot intervene in a firm’s operations. This may explain the prevalence in the

/pdf/blockholder-trading-market-efficiency-and-managerial-myopia-2aksuunxsb.pdf

Alex Edmans

Papers

Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices

Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices

Sports Sentiment and Stock Returns

Blockholder Trading, Market Efficiency, and Managerial Myopia

Blockholder Trading, Market Efficiency, and Managerial Myopia