“Media Reinforcement in International Financial Markets” by Prof. Ronnie Sadka
We introduce the possibility of a “reinforcement effect” between past returns and media-measured sentiment. When returns and sentiment point in the same direction (either up or down), prices are in the midst of overreacting. Such evidence of overreaction should disappear when returns and sentiment disagree. We find results supporting these views from parallel tests – across liquid individual stocks, international equity markets, and currencies – using weekly media scores for each asset culled from extensive data on cross-asset media coverage. The effect is mainly driven by the unique, non-overlapping information contained in returns and sentiment rather than a potential feedback effect. It is also consistently stronger in relatively more liquid assets, assets for which media coverage is relatively broad, and in subsets of media coverage generated by relatively more “local” news outlets. We show that a simple “reinforcement” strategy of buying past losers with low sentiment and selling past winners with high sentiment earns spreads of several hundred basis points annually.