1.1 Research Purpose and Motivation
We live in an ever-changing world, we face many uncertainties in our daily life.
The financial world is even more complex and constantly changing. In order to understand the important events that have occurred or will occur all over the world, investors gather information from the mass media. Information available on public media may show signs of firm-specific, industrial or macroeconomic financial warning.
Contents of financial warning related news play an important role in affecting investors’
perspective on the future trend and opportunities of the financial market. Rational investors would adjust their investment decisions according to the information that they have collected. These adjustments may help investors to benefit more from the financial market.
Text mining and sentiment analysis are techniques that scholars usually used to analyze the relationship between investors’ sentiment and the financial market.
Solomon (2012) suggested that the mass media help investors to process public information and decide which news event are economically important. Investor would expect greater profitability for corporations with more positive news, leading to a short-term price increases on that particular stock. Ferguson et al. (2013) suggested that news content would affect investors’ sentiment and content of news has strong predictive power on future stock market returns. There is a strong relationship between news content and investors’ trading decision in short-term. However, news articles do not impact the market in long run.
Most recent researches developed models to investigate the impact of firm-specific news on that particular stock. Li et al. (2014) quantified investors’ sentiment related to firm-specific news and examined its predictive power on future CSI 100 stock movements. Ferguson et al. (2013) examined the association between news tone (percentage of positive and negative words), future stock return and trade volume in the UK stock market. Both studies have proved that investors’ sentiment is associated with tone and volume of news available publicly. Investors’ sentiment affect investors’
investing behaviors and further enhance market volatility.
From recent scholars’ researches, we learn that firm-specific stock return and volume are affected by firm-specific investors’ sentiment. Investors’ sentiment would influence investor’s financial decision and affect market volatility. The Volatility Index can act as an indicator of overall investors’ sentiment. It represents the overall investors’
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level of confidence on the macroeconomic financial market. In this study, we would examine the impact of local industrial news and global stock market news on overall market volatility.
In this study, we will focus on analyzing the relationship between macroeconomic news sentiment and local market volatility. The financial market is globalized, firms expand their business to other countries and investors can invest in stock markets all over the world. Movements in major global equity market would affect local Taiwanese investors’ sentiment, as the movements may affect investors’ return and the businesses that the investors invested in. Global political issues and political environment changes in the Republic of China (R.O.C.) are issues that would affect the financial market, investors’ sentiment and their sense of security. Agarwal et al. (2017) suggested that during financial crisis uncertainty is high and high level of uncertainty would lead to high volatility in the financial market. We would investigate whether the mood and tone of news regarding issues of major local industries and global stock market would increase the overall market volatility. We believe that global political movements, natural disasters and some other financial events are signs of financial warning.
Therefore, we would further analyze the relationship between global stock market news, local industrial news and stock market volatility.
Financial distress is a condition that an enterprise experience difficulties in meeting or paying off the financial obligations to creditors. Financial warning is the sign that company are under financial distress or may face financial difficulties in the future. According to the fraud triangle suggested by Donald R. Cressey in the 1950s, there are three major factors that would persuade people to commit fraud. Those three factors are pressure, opportunity and rationalization. Pressure is what motivates an individual to commit fraud, when company are facing financial difficulties, the corporate management may have more incentive to alter financial records. Signs of financial warning may be discovered by the mass media and disclosed in news articles.
Information about non-firm-specific financial warning would affect investors’
confidence in a particular industry or the overall financial market. We would include elements and signs of financial warning in our sentiment dictionary to observe the association between macroeconomic financial warning and market volatility. The fraud triangle is shown in Figure 1-1.
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Figure 1-1 Fraud Triangle
We believe that macroeconomic and industrial news play an important role in impacting the financial market, global equity market and local industrial market news sentiment would be considered in our research model. News articles describing events in the macroeconomic world would be classified into local industrial news and global equity market news. The news tone and mood of both types of news will be quantified and scored. In this study, we would examine the effect of different types of external environment news on the overall market volatility in Taiwan. We believe that news articles would reveal signs of industrial-wide or market-wide financial warnings.
The impact of external environment news on the financial market can be measured by using the Volatility Index (VIX). Market volatility reflect investors’ sentiment, as investors adjust their investing behavior according to the information that they gathered.
VIX is introduced by the Chicago Board Options Exchange (CBOE) in 1993. It can be used to estimate the market expected volatility on Standard & Poor's (S&P) options over the next 30 days. VIX was originally designed to measure the implied volatility of S&P 100 index options. In 2003, the methodology of calculating VIX was revised, it expanded its range of calculation and measure the volatility of S&P 500 index options.
The revision enhances the accuracy of prediction on investor trading intention. VIX is calculated by averaging the weighted prices of S&P puts and calls over a wide range of strike prices. High volatility level reflects investors’ pessimism in the future and expects high trading level of options in the near future, and vice versa (Fernandes et al, 2014).
VIX can also be known as the investor fear index or the fear gauge, it can measure the level of fear and sense of security of investors on the financial market. VIX is a useful tool in investigating investors’ sentiment on the macroeconomic market.
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Our study focuses on quantifying the news sentiment of macroeconomic news, VIX calculated by CBOE is not a useful indicator of Taiwanese market volatility. The volatility index of Taiwan is calculated and published by the Taiwan Futures Exchange (TAIFEX). TAIFEX was established in 1998 under the Futures Trading Act, it offers futures and options on major Taiwanese stock indices, equity option etc. In 2006, the TAIFEX introduced the Taiwanese options volatility index (VIXTWN). VIXTWN can be used to measure the level of volatility on the Taiwanese option market. VIXTWN is calculated by using the formula developed by the CBOE, the application of VIX-formula by the TAIFEX is used under the authorization of S&P. In this study, we will use VIXTWN to measure the volatility level of the Taiwanese stock market. Figure 1-2 demonstrate the trend of VIXTWN between January 1-2007 and December 1-2017.
Figure 1-2 Trend Graph of VIXTWN
As we mentioned above, VIXTWN will be used to observe the changes in investors’ sentiment. In this study, we will focus on researching the impact of macroeconomic news on investors’ sentiment. Carretta et al. (2011) used the text mining and sentiment analysis techniques to quantify investors’ sentiment. In the study, news tone is used to measure investors’ sentiment, news tone can be determined by using the formula (P − N)/(P + N), where N and P represent the number of positive and negative words appeared in the financial news respectively. Negative words and positive word are classified according to the definition provided by the Harvard IV Psycho Social Dictionary. In this study, we further develop and enrich the dictionary built by the Innovative and Mobile Financial Service Technologies, Modeling and Applications project of the Ministry of Science and Technology. Words related to
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interaction between VIX and financial warning. Those financial warning related words are extracted from the dictionaries built by Chang (2009) and Lin (2013). We will use the integrated sentiment dictionary to analyze news tone and other sentiment variables of news. We believe that this research can contribute to the society by providing reasonable prediction about future market volatility trend when different macroeconomic events occur.
In this study, we would analyze the financial news article announced by CMoney, an Institutional Investors Investment Decision Supporting System, the research period is January 2007 to December 2017. In order to understand the relationship between macroeconomic events and market volatility, quantity of related news collected, their news tone and other sentiment variables will be examined.
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1.2 Research Problem
Based on the research’s purpose and motivation stated in Section 1, this study examines the relationship between macroeconomic news, macroeconomic and industrial financial warning and market volatility (VIXTWN). Research questions of this study are listed as follows:
1. How does the mood of local industrial news affect VIXTWN?
2. How does the mood of global stock market news affect VIXTWN?
3. Does the tone of local industrial market news affect VIXTWN?
4. Does the tone of global equity market news affect VIXTWN?
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1.3 Research Process
Our study begins with an Introduction. The introduction in Section 1 suggested the primary research purposes, the research motivation and briefly introduced the VIX index, investors’ sentiment, their backgrounds and relationships. Recent proposed literatures and related works are reviewed and discussed in Section 2, the literature review provide theoretical background and foundation for this study. In Section 3, detail discussion of hypothesis development, data collection, choice of variables, text analytic skills and the regression model of this study is provided. The empirical result of the study will be demonstrated in Section 4, including the descriptive statistics result, result of the regression model and the correlation analysis. The findings, limitations of the study and future research directions will be concluded in Section 5.
The research process is shown as follows:
Figure 1-3 Flow of Research Process Introduction
Literature Review
Research Method and Model Design
Empirical Result
Conclusion and Contribution
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2. Literature Review