Professional Documents
Culture Documents
Othman
Alolah
Pedro
Aguerreberry
Department
of
Finance
University
of
Tampa
July
2015
1
I.
INTRODUCTION
II.
MOTIVATION
There
are
several
investors
sentiment
indices
developed
in
the
last
two
decades
but
none
of
them
incorporate
the
powerful
influence
exerted
by
stock
analysts.
Thus,
this
index
could
provide
a
powerful
tool
to
explain
and
predict
security
returns.
Analysts
make
their
recommendations
based
on
reviewing
the
macroeconomic
scene
and
the
firm-specific
financials
and
other
non-economic
variables
such
as
management
team
changes,
potential
scandals.
Therefore,
we
argue
that
analysts
recommendations
have
incorporated
the
most
relevant
information
that
captured
the
value
of
a
security,
and
thus,
it
represent
an
interesting
base
of
the
suggested
investor
sentiment
index.
The
proposed
index
reflects
the
opinions
of
market
experts
who
influence
investors
through
platforms
such
as
news
media
and
Internet
websites.
Past
Research
have
proved
that
recommendations
that
were
passed
through
media
and
Internet
surly
affect
investors
sentiment
and
market
behavior.
(Trahan
and
Bolster)(1995)
examined
the
impact
on
stock
prices
of
purchase
recommendations
published
in
Barron's
publication.
Their
examination
showed
a
positive
and
significant
short-term
impact
on
stock
prices
at
the
time
of
publication.
According
to
(Tetlock)(2007),
high
levels
of
pessimism
showed
by
media
produced
a
downward
pressure
on
market
prices,
and
that
unexpected
low
or
high
levels
of
pessimism
led
the
trading
volume
temporarily
to
be
high.
(Arnold,
Earl,
and
North)(2007)
confirm
that
positive
stories
generally
indicate
the
end
of
superior
performance
and
4
negative
news
generally
indicates
the
end
of
poor
performance.
They
also
confirm
that
outperforming
companies
do
not
continue
to
outperform,
and
that
they
perform
equivalently
to
an
industry
matched
Peer
Company
after
the
cover
story
or
recommendation
appears.
(Loh
and
Stulz)(2010)
showed
that
investors
substantially
changed
their
assessments
and
valuations
of
a
firm
after
some
analysts
changed
their
recommendations
of
the
firm.
Analyst
recommendations
contain
market
and
industry-level
information
about
future
returns
and
earnings
that
are
indeed
helpful
when
making
the
investment
decision.
According
to
(Green)(2006)
brokerage
firm
clients
obtain
an
incremental
investment
value
in
the
form
of
a
short-term
profitability.
(Welch)(2000)
showed
that
the
buy
or
sell
recommendations
of
security
analysts
have
a
significant
positive
influence
on
the
recommendations
of
the
next
two
analysts.
Early
access
to
recommendation
changes
by
purchasing
upgrades
and
by
selling
short
downgrades
yields
positive
returns.
For
example,
(Womack)(1996)
finds
that
positive
(negative)
abnormal
returns
are
correlated
to
upgrades
(downgrades)
in
analyst
recommendations
right
after
are
announced.
(Howe,
Unlu,
and
Yan)(2009)
found
that
changes
in
aggregate
analyst
recommendations
forecast
future
market
excess
returns
after
controlling
for
macroeconomic
factors.
Moreover,
the
authors
provide
evidence
that
changes
in
industry
analyst
recommendations
predict
future
industry
returns.
Obviously,
past
literature
is
rich
with
studies
that
support
the
hypothesis
of
analysts
recommendations
spread
through
media
and
5
such
communication
channels
affecting
and
nudging
the
investors
behavior
in
the
stock
market.
In
assets-pricing
literature,
traditional
researchers
have
used
variables
that
are
related
to
firm-specific
and
macroeconomic
variables.
However,
in
the
last
decide,
scholars
have
increasingly
employed
some
psychological
variables
as
investor
sentiment
to
try
and
determine
asset
prices.
(Baker
and
Wurgler,
Investor
Sentiment
in
the
Stock
Market)(2007)
define
a
sentiment
index
as
a
linear
combination
of
six
variables:
the
closed-end
fund
discount,
the
logarithm
of
the
NYSE
share
turnover
ratio
(trended
by
the
5-year
moving
average),
the
number
of
IPOs,
the
average
first-day
return
on
IPOs,
the
share
of
equity
issues
in
total
equity
and
debt
issues
and
the
dividend
premium,
defined
as
the
log
difference
in
the
average
market-to-book
ratios
between
dividend
payers
and
non-payers.
Our
suggested
sentiment
index
can
be
tasted
as
determination
tool
for
asset
prices.
We
also
try
to
find
strategies
to
exploit
anomalies
that
generate
abnormal
returns.
Thus,
we
created
a
new
market
sentiment
index
to
predict
returns.
According
to
(Brown
and
Cliff)(2005),
if
excessive
optimism
drives
prices
above
intrinsic
values,
periods
of
high
sentiment
should
be
followed
by
low
returns,
as
market
prices
revert
to
fundamental
values.
(Brown
and
Cliff)(2005)
also
found
that
future
returns
over
multiyear
horizons
are
negatively
related
to
sentiment.
VI.
DATA
TO
BE
USED
V.
METHODS
The
proposed
methodology
estimates
the
bullish/bearish
spread
based
on
buy/
sell
recommendations
ratio.
Average
aggregated
recommendations
considering
all
publicly
traded
stocks
from
the
Russell
3000
are
calculated
quarterly
following
the
schedule
of
corporate
earnings
reports.
New
and
revised
recommendations,
which
were
issued
less
than
12
months
ago,
are
counted
equally
for
the
purpose
of
this
testing.
We
constructed
five
portfolios
to
determine
if
a
profitable
strategy
exists
based
on
market
sentiment
made
with
aggregate
analyst
recommendations.
We
intend
to
compare
the
market
sentiment
from
same
quarter
in
previous
year
to
measure
realized
returns
using
a
regression
analysis.
This
method
would
provide
with
a
significant
and
direct
correlation
between
variables.
We
also
plan
to
perform
a
validation
analysis
using
a
three-factor
model
(Fama,
et.
al,
1992).
We
would
incorporate
market
sentiment
to
the
cross-section
regression
analysis
performed
by
Fama-French
to
evaluate
the
index
performance
using
the
7
three-factor
model
(Fama,
et.
al,
1992).
The
variables
include
market
premium
to
measure
quarterly
excess
return
to
the
cap-weighted
Russell
3000;
Small
caps
on
the
basis
of
market
capitalization;
Stocks
ranked
quarterly
on
the
basis
of
book
value-per-share
to
market
price-per-share
ratio.
We
would
perform
a
regression
of
quarterly
excess
returns
on
the
three
variables
described
above
regressing
them
to
returns
based
on
market
sentiment.
We
expect
a
positive
market
sentiment
would
outperform
stocks
in
a
negative
market
sentiment.
Avg.
(strong
(buy)
(Hold)
(Sell)
(Strong
Rec.
1200
buy)
Q1
1200
# Avg.
Market
Realized
Rating
Sentiment
Returns
2.3
Greed
> 5%
Sell)
3200
1600
300
50
(Bullish)
%
19%
50%
25%
5%
1%
19%
Q2
200
500
2700
3200
100
200
3.4
Fear
< 1%
(Bearish)
%
3%
7%
40%
48%
1%
19%
Note:
Bearish
market
sentiment
should
not
be
confused
with
a
correction,
which
is
a
short-term
trend.
8
Market
Sentiment
S&P500
Expected
Returns
Range
High
Low
1 (strong buy)
35%
13%
2 (buy)
13%
7%
3 (Hold)
7%
2%
4 (Sell)
2%
-5%
5 (Strong Sell)
-5%
-30%
The
following
indicators
may
provide
additional
information
to
the
main
Sentiment
index
described
in
this
paper.
The
CBOE
Volatility
Index
(VIX)/
Put
and
Call
Options
volume
Bond/
gold
Demand
Number
of
short
positions
Spread
between
AAA
and
junk
bonds
Stock
Price
Breadth
(advance/decline
line)
Number
of
stocks
hitting
52-week
lows
Number
of
IPOs
Price
Dividend
Ratio
(above
26
may
signal
overvaluation)
VIII.
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12