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Electronic copy available at: http://ssrn.

com/abstract=2498160
Market events as predictors of stock returns
Mehmet Dicle, Ph.D.
Loyola University New Orleans
mfdicle@gmail.com
September 18, 2014
Abstract
This study suggests a method to select trading days when market information is
material to individual stocks
1
. While there are market-wide events in any given
day, not all of these events relate to each and every security. Thus, idiosyncratic
response is separated from market related response. Suggested method is tested
using daily prices for S&P-500 stocks for the 2005-2013 period. An out-of-
sample trading rule is tested for 2014. Economically and statistically significant
returns provide evidence to support the validity of the method.
Keywords: market news, market events, predicting returns, trading rule
JEL codes: G14, E44,
1
Disclaimer: This study does not suggest any trading (day-trade, short-term, long-term,
speculative etc.), does not provide any trading advice, does not provide investment advice,
does not provide financial advice and does not assume any liability whatsoever. Please do
your own analysis before making any financial decisions.
1
Electronic copy available at: http://ssrn.com/abstract=2498160
1 Introduction
Market plays an important part in individual security returns. Capital asset
pricing model (CAPM) (Sharpe, 1964; Lintner, 1965) suggests that a significant
portion of stock returns can be explained by the market returns. The definition
of the market, according to CAPM, is in its broadest sense. It should include
all investible assets, domestic and foreign. If there is a shock to the market, as
news or events, domestic or international, individual stocks should react to this
shock in accordance with their dependence on the overall market.
Bartolini et al. (2008) and Boyd et al. (2005), for instance, argue that stock
prices are effected by the new economic data. However, not every news or events
are relevant to each and every stock. On the other hand, Roll (1988) is one of
the earliest studies that argues against price reactions to market news.
There are also efforts to identify the effect of news on returns. Textual
analysis methodology (i.e. Tetlock et al., 2008; Loughran and McDonald, 2011)
evaluates news, comments, articles using certain keywords and attempts to mea-
sure sentiment.
This study provides an empirical method to select trading days when an
unknown market event has effected individual stocks. In other words, I construct
a stock specific time series binary variable that is assigned a value of one if a
particular trading day witnessed a market event that is material for the stock. If
a researcher hand collects market events data, s/he is likely to miss comments,
international events or what is material for individual stocks. S/he also needs
to rely on his/her expertise to judge the importance of the event for the overall
market as well as for the individual stocks. Texual analysis relies on certain
keywords to analyze sentiment which can be biased and prone to errors.
Random walk theory (Malkiel, 1973; Samuelson, 1965) suggests that the
stock returns are random and therefore unpredictable. Market efficiency (Fama,
2
1965, 1970, 1991) implies that the current prices include all public information.
However, evidence of behavioral trading is common (i.e. Shiller, 2003). If there
is an important market event (i.e. Scottish independence referendum) the entire
market will react to it. The exact effect of independent Scotland is unknown
to the ordinary investor and perhaps not certain for expert investor. If the
immediate reaction is a sell off based on weakened British Pound and therefore
risk for world economy, it wouldn’t be surprising to see a herding effect (i.e.
Bikhchandani and Sharma, 2000). Following few days will probably witness
corrective actions. For some investors, it will be to sell more. For some others it
will pose a buying opportunity. Such overreactions are well documented in the
literature (i.e. Chan, 2003; Gutierrez and Kelley, 2008; Tetlock et al., 2008). It
is this common reaction that I test the validity of the suggested model to select
market event days.
Implications are academic, professional and regulatory. Random walk and
market efficiency theories are questioned around certain market events: patterns
become predictable and possibly sticky and therefore unavoidable. Predicting
patterns around certain market events make it possible for professionals to ex-
ploit trading opportunities for similar repeat market events. Ability to forecast
investor reaction for market events could provide opportunities to take regu-
latory precautions such as short-sale ban, margin requirements etc. to limit
market volatilities and possible attempts to manipulation. This would espe-
cially be important for developing financial markets.
2 Literature review
The purpose of this study is to select the market event days that are material
to each individual stock.
The mainstream effort in this direction has been towards finding important
3
market or company events (i.e. Tetlock et al., 2008; Griffin et al., 2011; Loughran
and McDonald, 2011). Texual analysis (i.e. Tetlock et al., 2008; Loughran and
McDonald, 2011) is usually based on keyword, phrase and/or other string based
algorithmic search within news, comments, articles or other sources. The intent
of such searches is usually to understand the impact of certain news on equity
prices. This is similar to event studies.
The general assumption is that certain news will effect prices in certain
ways and such effect will be continuous. However, price does not react only to
news, even if they are the most prevailing news. Furthermore, price reaction to
certain news may be different under different economic circumstances. There
are numerous information and events that take place during any given day. It is
virtually impossible to differentiate the impact of each piece of news (or event)
independent of others. Such searches are subject to researchers’ expertise and
objectivity.
Empirically, CAPM models the returns for stocks. It would be possible for
us to mark the trading days when the estimated errors are closest to zero. These
specific days would be when the market explains the individual stock’s return
the most. However, this method could present problems. The goodness of fit
for market model is not perfect. There could be other factors that effect the
overall market and the stock (i.e. coincidence). Furthermore, the channels in
which market return explains individual stock returns may not be complete.
It is argued that the commonality in liquidity (Chordia et al., 2000; Kora-
jczyk and Sadka, 2008; Karolyi et al., 2012) is due to channels that may be
different than the commonality in returns. Market makers’ inventory risk, for
instance, becomes one of the reasons for the commonality in liquidity.
Thus, selecting a market event day based on two data points provides a
more robust method. Commonality in liquidity complements the commonality
4
in returns for the purposes of identifying days when market events take place.
3 Method and data
3.1 Models
Two models will provide the basis for the suggested method. First model is the
simple market model as follows.
r
i,t
= α
r
+ β
r
r
m,t
+
r,i,t
(1)
In Equation 1, r refers to daily return calculated as log difference of split
and dividend adjusted daily prices, i refers to the individual stocks, m refers
to the market and t refers to the trading day. The residuals,
r,i,t
, are used to
construct the suggested method.
The second model is the commonality in trading activity. It is estimated as
follows:
v
i,t
= α
v
+ β
v
r
m,t
+
v,i,t
(2)
In Equation 2, v refers to daily change in volume calculated as log difference
of daily share volume. The residuals,
v,i,t
, are used to construct the suggested
method. The intention of this study is to provide a replicatable and a usable
method for academics and professionals. Access to intraday data with bid and
ask prices is not as common (i.e. I do not have access to such data). Thus,
a trading activity measure is used instead of bid-ask spread based liquidity
measures.
5
3.2 Method
I argue that the dependence of a stock return on the market return is at its
highest when
r,i,t
is closest to zero. I also argue that dependence of a stock’s
trading activity on the market trading activity is at its highest when
v,i,t
is
closest to zero. Therefore, both
r,i,t
and
v,i,t
are sorted into ten categories,
cat
r,1→10
and cat
v,1→10
respectively.
Market event binary variable me
i,t
is assigned a value of one if the
r,i,t
and

v,i,t
are both within the lowest four categories.
me
i,t
=







1, if (
r,i,t
∈ cat
r,1→4
) ∧ (
v,i,t
∈ cat
v,1→4
)
0, otherwise
(3)
The binary variable, me
i,t
, is unique to each stock (i) and it is time series
(t). These are the trading days when market event or information is most
material for the particular stock. There could be other days when important
market events occur but these events may not be of particular importance for
the specific stock.
3.3 Data
Data for the study are downloaded from Yahoo! Finance
2
. Data include, split
and dividend adjusted daily prices for individual S&P-500 stocks, index level for
the S&P-500 as well as daily opening and closing levels for S$P-500 index. Data
also includes daily trading volume for stocks as well as for the entire index.
Dollar value for the trading volume is not used to avoid endogeneity between
returns and volume. Since Equation 1 is estimated using daily returns that use
daily prices, using daily change in US Dollar value of volume would also include
the daily change in prices.
2
Available through http://finance.yahoo.com
6
4 Trading rule
A buy trigger (buy
i,t
) is generated for days following a market event (me
i,t−1
=
1), and S&P-500 has a daily positive return that is greater than 0.10%. Daily
positive return for this trading rule refers to open to close return (log difference
of close and open) for the day.
As previously stated, if
r,i,t
and
v,i,t
are within lowest four categories then
the trading day is assigned as market event day (me
i,t
= 1). The reason that
lowest four categories are used is because the trading rule using the lowest four
categories provides highest returns for the 2005-2013 period.
The second condition for the buy trigger is the intraday return for the S&P-
500 which is also determined by testing alternates for the 2005-2013 period.
Since the conditions of the trading rule is based on the 2005-2013 period,
2014 is used as an out-of-sample test. Although, almost every combination of
the two conditions provide positive returns.
5 Empirical results
Tables 1 through 4 provide descriptive statistics for the trading rule returns.
Return is calculated for each trading rule buy signal for each stock. These
returns make up the date for these tables. Mean refers to the mean trading rule
return across buy signals and across stocks for each year. Table 1 is based on
the trading rule returns for a duration of one day after the buy signal. Table 4
on the other hand is based on four days of holding period after the buy signal.
There can be multiple positions during any trading day.
2005-2013 period is used to develop the parameters for the trading rule
conditions. 2014 is used as an out of sample period. Thus, for individual years
and for individual durations, the results may not be optimal. However, the
7
optional parameters (for 2005-2013) are used for the 2014. The results for the
2005-2013 period are provided for information purposes. 2014 is the actual
result of the trading rule.
For all durations, mean trading rule returns are positive. They are economi-
cally and statistically significant. Keep in mind that these are net returns. They
are not annualized. For instance, 0.2479 for three days duration is a net return
for three days. It corresponds to 19.81% compounded return over a year
3
.
Maximum trading rule returns are also compared to the minimum returns.
These set the range for trading rule risk. For all durations, maximum trading
rule returns are higher than the minimum returns.
I acknowledge that the markets were almost constantly bullish after 2008
until the current day. However, the trading rule is provided as an evidence for
the robustness of the suggested methodology for selecting market event dates.
Therefore, the intent is not to create a trading rule per se. The fact that majority
of the years, without optimal trading rule parameters, provide positive trading
rule returns support the main argument. The trading rule does not employ any
short positions and it does not resort to technical analysis tools to separate bull
trends from bear trends.
Table 5 provides the trading rule results for the 2014 for the components of
Dow Jones Industrial index
4
.
Trading rule for this table uses five common error categories and 0.10%
S&P-500 intraday return for the buy signal day. Mean returns (µr) and total
returns (Σr) for different durations are provided. Beta and R-squared statistics
from Equations 1 and 2 are also provided for information purposes. Number of
observations (Obs.) refer to the number of trading rule buy signals during 2014.
3
Considering 220 trading days in a year, instead of 365 calendar days since the return is
based on actual trading days.
4
Components of Dow Jones Industrial index instead of S&P-500 are provided to conserve
space. Results for the entire S&P-500 are available upon request.
8
Figures are percentages, i.e. 0.5 refers to 0.5%.
The results are economically significant. There are 15.03 (14.68 for S&P-
500) trades on average. 63% (65.99% for S&P-500) of the stocks had positive
returns. The average of mean negative returns is -0.16% (-0.39% for S&P-500)
whereas the average of the mean positive returns is 0.5% (0.58% for S&P-500).
6 Summary and concluding remarks
The purpose of this study is to provide a method for distinguishing trading days
that are market driven. Market-wide events exist for each trading day. These
events may not be equal in importance across stocks. Hand collecting such event
(domestic or international) is not feasible and not reliable. Researchers’ ability
and bias will effect the data quality. It is also not possible to predict how much,
if at all, each market event will effect individual stocks.
Therefore, an empirical method is suggested that utilizes two major avenues
of financial literature, namely commonality in returns (CAPM) and common-
ality in liquidity. Channels in which market returns explain individual stock
returns are beyond the scope of this study. However, suffice to say that the
channels in which return interactions and liquidity interactions are complimen-
tary.
Estimating the residuals using common market model for return and for
trading activity, I created a binary variable to select trading days as market
event days when the residuals for both models were close to zero. These days
are when the market is most explanatory of the individual stocks’ behavior.
In order to test the method, a simple trading rule is employed. A buy signal
is generated following each market event day. If the investors are reacting to
market events by trading individual stocks, there should be correction following
the market event. Since we had a bull market after the 2007 crisis, the trading
9
rule only considers upside correction and does not evaluate downside correc-
tions. The trading rule is to provide evidence for the market event selection
methodology. The intent is not to create the most profitable trading rule.
Trading rule returns are positive on average and in total for individual S&P-
500 stocks. This evidence supports the validity of the market events selected by
the suggested methodology.
It would be a natural extension for this study to test the method using intra-
day liquidity data instead of the trading activity. It would also be interesting to
use the market events methodology within a forecasting model to predict ma-
jor market reactions. Market event days can be used to separate idiosyncratic
variance from market variance leading to a stock specific risk measures.
10
References
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markets. Current Issues in Economics and Finance (Federal Reserve Bank of
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unemployment news: Why bad news is usually good for stocks. Journal of
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work. Journal of Finance 25(2), 383–417.
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financial media in global markets? Review of Financial Studies 24(12), 3941–
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ality in liquidity around the world. Journal of Financial Economics 105(1),
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native measures of liquidity. Journal of Financial Economics 87(1), 45–72.
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Tetlock, P. C., M. Saar-Tsechansky, and S. Macskassy (2008). More than
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7 Appendix: Figures
Figure 1: Daily price chart for AAPL with market events.
14
8 Appendix: Tables
Table 1: Descriptive statistics for the mean percentage profit/loss, per
trade, across stocks, for one day after the trading rule buy trigger. Figures
are in percent, i.e. 0.5 refers to 0.5%. *, ** and *** refer to statistical signifi-
cance at the 10%, 5% and 1% respectively.
Year Mean Min. Max. Stdev. Std.Err.
2005 -0.0298 -3.1507 1.8905 0.4073 0.0191
2006 0.1105 *** -0.9709 2.0189 0.3501 0.0163
2007 -0.0364 * -2.1047 1.5791 0.4220 0.0195
2008 -0.4934 *** -5.7658 2.2702 0.7745 0.0356
2009 0.0468 * -2.5763 3.3051 0.6162 0.0282
2010 0.0954 *** -1.3401 1.7343 0.3759 0.0171
2011 0.0498 ** -2.4664 4.2314 0.5158 0.0234
2012 0.1216 *** -1.1700 2.3387 0.3644 0.0164
2013 0.0480 *** -1.3719 0.8775 0.2633 0.0118
2014 0.0571 *** -0.8759 1.2286 0.3009 0.0135
Table 2: Descriptive statistics for the mean percentage profit/loss, per
trade, across stocks, for two days after the trading rule buy trigger. Fig-
ures are in percent, i.e. 0.5 refers to 0.5%. *, ** and *** refer to statistical
significance at the 10%, 5% and 1% respectively.
Year Mean Min. Max. Stdev. Std.Err.
2005 0.0682 *** -2.1150 2.8866 0.5281 0.0247
2006 0.0911 *** -1.7916 1.8837 0.4902 0.0228
2007 0.0131 -3.5468 2.4527 0.6331 0.0293
2008 -0.8231 *** -7.5893 2.1326 1.0651 0.0489
2009 0.1536 *** -4.0812 3.2549 0.9135 0.0418
2010 0.1505 *** -2.1904 2.6511 0.6055 0.0276
2011 -0.0086 -2.9909 6.9071 0.7546 0.0342
2012 0.1453 *** -2.1549 4.1055 0.5697 0.0257
2013 0.1554 *** -2.3772 1.7062 0.4308 0.0193
2014 0.1453 *** -1.2870 2.0889 0.4631 0.0208
15
Table 3: Descriptive statistics for the mean percentage profit/loss, per
trade, across stocks, for three days after the trading rule buy trigger. Fig-
ures are in percent, i.e. 0.5 refers to 0.5%. *, ** and *** refer to statistical
significance at the 10%, 5% and 1% respectively.
Year Mean Min. Max. Stdev. Std.Err.
2005 0.1489 *** -3.0385 5.0760 0.7215 0.0338
2006 0.1470 *** -2.0238 2.1219 0.6170 0.0287
2007 0.1337 *** -3.3998 4.4282 0.8259 0.0382
2008 -1.0103 *** -7.1466 2.2606 1.2231 0.0562
2009 0.2724 *** -3.7685 5.1520 1.0694 0.0489
2010 0.2355 *** -3.2872 2.9221 0.7692 0.0351
2011 -0.1066 ** -3.7049 5.9121 0.9193 0.0417
2012 0.1119 *** -2.3710 4.0013 0.6922 0.0312
2013 0.2419 *** -3.0819 4.6517 0.5604 0.0251
2014 0.2479 *** -1.8121 2.6584 0.6145 0.0276
Table 4: Descriptive statistics for the mean percentage profit/loss, per
trade, across stocks, for four day after the trading rule buy trigger. Figures are
in percent, i.e. 0.5 refers to 0.5%. *, ** and *** refer to statistical significance
at the 10%, 5% and 1% respectively.
Year Mean Min. Max. Stdev. Std.Err.
2005 0.1693 *** -4.4249 10.9629 0.9641 0.0452
2006 0.2307 *** -2.4195 3.2123 0.7232 0.0337
2007 0.1550 *** -8.9066 6.5094 1.1094 0.0513
2008 -1.1416 *** -11.0788 4.8298 1.5031 0.0690
2009 0.4467 *** -6.2020 7.1617 1.3008 0.0595
2010 0.2750 *** -3.3980 4.0401 0.8854 0.0404
2011 -0.1098 ** -4.2664 6.6501 1.0455 0.0474
2012 0.0191 -2.4800 4.5848 0.8418 0.0380
2013 0.4066 *** -3.6795 5.1156 0.6652 0.0298
2014 0.2930 *** -2.0329 2.7934 0.7050 0.0316
16
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17
9 Appendix: Stata code for replication
Stata is used for this study. Along with Stata’s own commands a few user writ-
ten commands are utilized including mfd dm prices
5
provided by Dicle (2013)
and Dicle and Levendis (2011).
9.1 Download the data
1 mfd_dm_components_cnn
2 levelsof Symbol , local(tickers)
3 mfd_dm_prices ‘tickers ’ ^GSPC , freq(d) chg(ln) start (01 jan2005)
field(o c v)
4 gen year=year(date)
5 gen day=_n
6 tsset day
7 save research_data.dta , replace
9.2 Models, construct and the trading rule
1 forval yr =2005/2014{
2 forval error_level =4/5 {
3 forval GSPC_lvl =10(5) 50 {
4 local GSPC_level=‘GSPC_lvl ’/10000
5 foreach ticker in ‘tickers ’ {
6 di "‘yr’_‘error_level ’_‘GSPC_lvl ’: ‘ticker ’"
7 qui: {
8 use if year==‘yr’ using research_data.dta , clear
9
10 summ ln_ ‘ticker ’
11 if r(N)>0 {
12 gen ln_volume_ ‘ticker ’=ln(volume_ ‘ticker ’/L.volume_ ‘
ticker ’)
13 gen ln_volume__GSPC=ln(volume__GSPC/L.volume__GSPC)
14
5
This user written command can be installed from http://stat.researchforprofit.com.
18
15 reg ln_ ‘ticker ’ ln__GSPC
16 predict double resid_ln_ ‘ticker ’, residuals
17 gen abs_resid_ln_ ‘ticker ’=abs(resid_ln_ ‘ticker ’)
18 reg ln_ ‘ticker ’ ln__GSPC
19 gen ln_beta=_b[ln__GSPC]
20 gen ln_r2=e(r2)
21
22 reg ln_volume_ ‘ticker ’ ln_volume__GSPC
23 predict double resid_vol_ ‘ticker ’, residuals
24 gen abs_resid_vol_ ‘ticker ’=abs(resid_vol_ ‘ticker ’)
25 reg ln_volume_ ‘ticker ’ ln_volume__GSPC
26 gen vol_beta=_b[ln_volume__GSPC]
27 gen vol_r2=e(r2)
28
29 xtile xtile_return = abs_resid_ln_ ‘ticker ’, nq(10)
30 xtile xtile_volume = abs_resid_vol_ ‘ticker ’, nq(10)
31
32 gen event=.
33 replace event=adjclose_ ‘ticker ’ if xtile_return <‘
error_level ’ & xtile_volume <‘error_level ’
34
35 gen oc_ln__GSPC=ln(close__GSPC/open__GSPC)
36
37 gen event1 = L1.ln_ ‘ticker ’ if (L2.event !=.) & (L2.
oc_ln__GSPC >=‘GSPC_level ’)
38 gen event2 = L1.ln_ ‘ticker ’ + L2.ln_ ‘ticker ’ if (L3.
event !=.) & (L3.oc_ln__GSPC >=‘GSPC_level ’)
39 gen event3 = L1.ln_ ‘ticker ’ + L2.ln_ ‘ticker ’ + L3.ln_ ‘
ticker ’ if (L4.event !=.) & (L4.oc_ln__GSPC >=‘
GSPC_level ’)
40 gen event4 = L1.ln_ ‘ticker ’ + L2.ln_ ‘ticker ’ + L3.ln_ ‘
ticker ’ + L4.ln_ ‘ticker ’ if (L5.event !=.) & (L5.
oc_ln__GSPC >=‘GSPC_level ’)
41
19
42 collapse (sum) sum_event1=event1 sum_event2=event2
sum_event3=event3 sum_event4=event4 (mean)
mean_event1=event1 mean_event2=event2 mean_event3=
event3 mean_event4=event4 (firstnm) ln_beta ln_r2
vol_beta vol_r2 (count) N=event1
43 gen symbol="‘ticker ’"
44 gen year=‘yr’
45 gen error_level=‘error_level ’
46 gen GSPC_level=‘GSPC_level ’
47 capture: append using market_event.dta
48 save market_event.dta , replace
49 }
50 }
51 }
52 }
53 }
54 }
20