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on Financial Markets |
| By: | Kemal Kirtac; Guido Germano |
| Abstract: | We investigate the efficacy of large language models (LLMs) in sentiment analysis of U.S. financial news and their potential in predicting stock market returns. We analyze a dataset comprising 965, 375 news articles that span from January 1, 2010, to June 30, 2023; we focus on the performance of various LLMs, including BERT, OPT, FINBERT, and the traditional Loughran-McDonald dictionary model, which has been a dominant methodology in the finance literature. The study documents a significant association between LLM scores and subsequent daily stock returns. Specifically, OPT, which is a GPT-3 based LLM, shows the highest accuracy in sentiment prediction with an accuracy of 74.4%, slightly ahead of BERT (72.5%) and FINBERT (72.2%). In contrast, the Loughran-McDonald dictionary model demonstrates considerably lower effectiveness with only 50.1% accuracy. Regression analyses highlight a robust positive impact of OPT model scores on next-day stock returns, with coefficients of 0.274 and 0.254 in different model specifications. BERT and FINBERT also exhibit predictive relevance, though to a lesser extent. Notably, we do not observe a significant relationship between the Loughran-McDonald dictionary model scores and stock returns, challenging the efficacy of this traditional method in the current financial context. In portfolio performance, the long-short OPT strategy excels with a Sharpe ratio of 3.05, compared to 2.11 for BERT and 2.07 for FINBERT long-short strategies. Strategies based on the Loughran-McDonald dictionary yield the lowest Sharpe ratio of 1.23. Our findings emphasize the superior performance of advanced LLMs, especially OPT, in financial market prediction and portfolio management, marking a significant shift in the landscape of financial analysis tools with implications to financial regulation and policy analysis. |
| Date: | 2024–12 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2412.19245 |
| By: | Duraj, Kamila; Grunow, Daniela; Chaliasos, Michael; Laudenbach, Christine; Siegel, Stephan |
| Abstract: | We revisit the limited stock market participation puzzle leveraging a qualitative research approach that is commonly used in many social sciences, but much less so in economics or finance. We conduct in-depth interviews of stock market investors and non-investors in Germany, a highincome country with a low stock market participation rate. Differently from a survey using preset questions based on theory, we elicit views in an open-ended discussion, which starts with a general question about "money, " is not flagged as regarding stock market participation, and allows for probing and follow-up questions. Many of the factors proposed by the literature are mentioned by interviewees. However, non-investors perceive surprisingly high entry and participation costs due to a fundamental misconception of the potential for selecting "good" stocks and avoiding "bad" ones and for market timing through continuous monitoring and frequent trading. Surprisingly, the investors we interview often share these views. However, they find a way to overcome these perceived costs with the help of family, friends, or financial advisors they trust. While the insights from our qualitative interviews are based on a small number of interviewees, we find consistent evidence in a population-wide survey of investors and non-investors. |
| Keywords: | participation costs, stock market participation, qualitative research, investing, efficient markets |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:safewp:308097 |
| By: | Berg, Florian; Heeb, Florian; Kölbel, Julian |
| Abstract: | This study examines the impact of ESG ratings on fund holdings, stock returns, and firm behavior. First, we show that among five major ESG ratings, only MSCI ESG can explain the holdings of US funds with an ESG mandate. We document that downgrades in the MSCI ESG rating substantially reduce firms' ownership by such funds, while upgrades increase it. However, this response in ownership is slow, unfolding gradually over a period of up to two years. This suggests that fund managers use ESG ratings mainly to comply with ESG mandates rather than treating them as updates to firms' fundamentals. Accordingly, we also find a slow and persistent response in stock returns. For a one-year holding period, downgrades lead to an abnormal return of -2.37%. For upgrades, we find a positive but weaker effect. Yet, the extent to which ESG ratings matter for the real economy seems limited. We find no significant effect of up- or downgrades on firms' subsequent capital expenditure. We find that firms adjust their ESG practices following rating changes, but only in the governance dimension |
| Keywords: | Responsible investing, social impact, ESG ratings, asset prices, corporate investment, corporate governance |
| JEL: | G11 G12 G32 G34 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:safewp:308045 |
| By: | Daniel Barth; Phillip J. Monin; Emil N. Siriwardane; Adi Sunderam |
| Abstract: | Since 2013, large U.S. hedge fund advisers have been required to report risk exposures in their regulatory filings. Using these data, we first establish that managers’ perceptions of risk contain useful information that is not embedded in fund returns. Investor flows do not respond to this information when managers perceive higher risk than what their past returns would indicate, suggesting managers strategically communicate their risk assessments with investors. During market downturns, investors withdraw capital from funds whose managers perceive higher risk, suggesting they find the performance of these funds in adverse market conditions surprising. These funds are identifiable ex-ante with information that is available to investors. |
| Keywords: | Delegated asset management; Hedge funds; Institutional investors; Investor behavior; Investor flows; Principal agent theory; Risk |
| JEL: | G23 G14 D82 G11 |
| Date: | 2024–12–20 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-98 |
| By: | Yevgeny Mugerman (Hebrew University of Jerusalem); Nadav Steinberg (Bank of Israel) |
| Abstract: | This paper investigates the causal relationship between changes in mutual fund management fees and fund flows using a comprehensive dataset of daily fund flows. Our analysis provides evidence of investor responsiveness to fee adjustments: an increase in fees leads to a decrease in net inflows, and a decrease in fees leads to an increase in net inflows. We address endogeneity concerns through various methods, including distinguishing between anticipated and surprising fee changes, using instrumental variables, and leveraging two regulatory reforms that affected management fees based on fund type or fee structure. By distinguishing inflows from outflows, we find that new investments are more sensitive to fee changes than existing investments. Using a proprietary database of all mutual fund holdings, we find that new investments by current fund investors drive this sensitivity. While on average our findings challenge the prevailing notion that retail investors are passive and inattentive to investment costs, we do find that investors in high management fee funds are much less sensitive to further fee increases. |
| Keywords: | Mutual Funds, Management Fee Changes, Retail Investors |
| JEL: | G18 G28 G23 G41 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:boi:wpaper:2024.12 |
| By: | Gordon Anderson; Oliver Linton |
| Abstract: | For the last 60 years, Expected Utility Theory, Rational Expectations, and a tacit presumption of symmetry in outcome distributions have been the micro and macro foundations of decision-making paradigms which seek optimum risk tempered expected outcomes. The Sharpe ratio, in its use in evaluating portfolio performance and its focus on average returns, epitomizes the practice. When outcome distributions are symmetric unimodal, expected and most likely outcomes coincide, and choices can be construed as being made on the basis of either. However, when outcome distributions are asymmetric or multi-modal, expected outcomes are not the most likely and, in contradiction of rational expectations assumptions, expectations-based choice will engender systematic information laden surprises raising questions as to whether choice should be most likely or expected outcome based. Here, the impact of switching to a Most Likely view of the world is examined and “Most Likely†focused versions of the Sharpe and Sortino Ratios are introduced. Simple exercises performed on commonly used benchmark portfolio and stock returns data demonstrate that portfolio orderings change substantially when the focus is switched to most likely outcomes, all of which gives some pause for thought. |
| Keywords: | Portfolio choice, expected outcomes, most likely outcomes, Sharpe Ratio, Sortino Ratio |
| JEL: | G11 C14 C18 |
| Date: | 2024–12–19 |
| URL: | https://d.repec.org/n?u=RePEc:tor:tecipa:tecipa-787 |
| By: | Lorenzo Bretscher (Swiss Finance Institute - HEC Lausanne; Centre for Economic Policy Research (CEPR)); Peter Feldhütter (Copenhagen Business School); Andrew Kane (Fuqua School of Business, Duke University); Lukas Schmid (University of Southern California - Marshall School of Business) |
| Abstract: | Traditional tests of the credit spread puzzle are imprecise. We show that a key input of these tests, the equity Sharpe ratio, is difficult to estimate in available empirical samples. Instead, we show that the difference between the Sharpe ratios of debt returns and equity returns provides a more precise test. Using the new test we find no evidence for a credit spread puzzle in the corporate bond market: after controlling for the unexpected decline in interest rates beginning in the 1990s, the Sharpe ratios of equity and bonds of high quality firms are nearly identical. However, we uncover a new puzzle in the market for bank debt: loan returns have higher Sharpe ratios than equity returns. |
| Keywords: | credit spread puzzle, credit risk, corporate debt, bond pricing, loan pricing |
| Date: | 2024–01 |
| URL: | https://d.repec.org/n?u=RePEc:chf:rpseri:rp2467 |
| By: | Walter Engert; Oleksandr Shcherbakov; André Stenzel |
| Abstract: | We investigate the introduction of a central bank digital currency (CBDC) into the market for payments. Focusing on the point of sale, we develop and estimate a structural model of consumer adoption, merchant acceptance and usage decisions. We counterfactually simulate the introduction of a CBDC, considering a version with debit-like characteristics and one encompassing the best of cash and debit, and characterize outcomes for a range of potential adoption frictions. We show that, in the absence of adoption frictions, CBDC has the potential for material consumer adoption and merchant acceptance, along with moderate usage at the point of sale. However, modest adoption frictions substantially reduce outcomes along all three dimensions. Incumbent responses required to restore pre-CBDC market shares are moderate to small and further reduce the market penetration of CBDC. Overall, this implies that an introduction of CBDC into the market for payments is by no means guaranteed to be successful. |
| Keywords: | Bank notes; Digital currencies and fintech; Econometric and statistical methods; Financial services |
| JEL: | C51 D12 E42 L14 L52 |
| Date: | 2024–12 |
| URL: | https://d.repec.org/n?u=RePEc:bca:bocawp:24-52 |
| By: | Fulvia Fringuellotti; Thomas Kroen |
| Abstract: | In June 2020, the Federal Reserve issued stringent payout restrictions for the largest banks in the United States as part of its policy response to the COVID-19 crisis. Similar curbs on share buybacks and dividend payments were adopted in other jurisdictions, including in the eurozone, the U.K., and Canada. Payout restrictions were aimed at enhancing banks’ resiliency amid heightened economic uncertainty and concerns about the risk of large losses. But besides being a tool to build capital buffers and preserve bank equity, payout restrictions may also prevent risk-shifting. This post, which is based on our recent research paper, attempts to answer whether and how payout restrictions reduce bank risk using the U.S. experience during the pandemic as a case study. |
| Keywords: | banking; payout restrictions; risk-shifting; prudential regulation |
| JEL: | G21 G28 G35 G38 |
| Date: | 2025–01–08 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fednls:99404 |
| By: | Dan Li; Phillip J. Monin; Lubomir Petrasek |
| Abstract: | Constraints on the supply of credit by prime brokers affect hedge funds' leverage and performance. Using dealer surveys and hedge fund regulatory filings, we identify individual funds' credit supply from the availability of credit under agreements currently in place between a hedge fund and its prime brokers. We find that hedge funds connected to prime brokers that make more credit available to their hedge fund clients increase their borrowing and generate higher returns and alphas. These effects are more pronounced among hedge funds that rely on a small number of prime brokers, and those that rely on borrowing rather than derivatives for their leverage. Credit supply matters more for hedge fund performance during periods of financial market stress and when trading opportunities are abundant. |
| Keywords: | Hedge funds; Dealers; Leverage; Prime brokerage; Financing; Surveys |
| JEL: | G23 |
| Date: | 2024–11–21 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-89 |
| By: | Mateo Velásquez-Giraldo |
| Abstract: | Survey measurements of households’ expectations about U.S. equity returns show substantial heterogeneity and large departures from the historical distribution of actual returns. The average household perceives a lower probability of positive returns and a greater probability of extreme returns than history has exhibited. I build a life-cycle model of saving and portfolio choices that incorporates beliefs estimated to match these survey measurements of expectations. This modification enables the model to greatly reduce a tension in the literature in which models that have aimed to match risky portfolio investment choices by age have required much higher estimates of the coefficient of relative risk aversion than models that have aimed to match age profiles of wealth. The tension is reduced because beliefs that are more pessimistic than the historical experience reduce people’s willingness to invest in stocks. |
| Keywords: | Consumption and Saving; Heterogeneous Beliefs; Life cycle dynamics; Portfolio choice |
| JEL: | G11 G40 G51 G53 E21 D15 |
| Date: | 2024–12–20 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-97 |
| By: | Fadavi, Sara; Hillert, Alexander |
| Abstract: | SAFE's monthly Manager Sentiment Index is constructed by extracting sentiment from corporate financial disclosures of listed companies in Germany, offering significant insights into top management's perspectives. This white paper outlines the methodology behind the index and its financial implications. Information about managers' assessment of firms' performance and financial conditions is material to investors but, at the same time, hard to observe. The SAFE Manager Sentiment Index quantifies managers' beliefs using textual analysis of financial reports and earnings conference call transcripts. We show that the index is a strong predictor of future stock market returns. In summary, the SAFE Manager Sentiment Index provides a practical tool for key stakeholders such as investors, analysts, and policymakers seeking timely signals of corporate sentiment. |
| Keywords: | Manager Sentiment, Textual Analysis, Financial Disclosures, Return Predictability |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:safewh:308085 |