News Sentiment to Market Impact and its Feedback Effect

Abstract

Digitization of news articles and the advancement of computational intelligence applications have led to a growing influence of news sentiment over financial markets in recent years. News sentiment has often been used as a proxy for gauging investor’s sentiment and reflecting the aggregate confidence of the society toward future market. Previous studies have primarily focused on elucidating the unidirectional impact of news sentiment on market returns and not vice versa. In this study, we document the presence of a significant feedback effect between news sentiment and market returns across the major indices in the U.S. financial market. We find that news sentiment exhibits a lag-4 effect on market returns and conversely market returns elicit consistent lag-1 and lag-2 effects on news sentiment. This aligns well with our intuition that news sentiment drives trading activity and investment decisions. In turn, heightened investment activity further stimulates involuntary responses, which manifest in the form of more news coverage and publications. The evidence presented highlights the strong correlation between news sentiment and market returns, and demonstrates the potential benefits of advancing knowledge in sentiment modeling and its interaction with market movement.