INCORPORATING NEWS ANALYTICS INTO QUANTITATIVE INVESTMENT AND TRADING STRATEGIES

Rich Brown Global Business Manager Machine Readable News London November 17, 2010

EXPLOITING NEWS CONTENT
• News is emerging as differentiated, value generating content set
– Quant strategies – all trading frequencies – Human decision support – especially with analytics

• Key uses
– Speed – beat the humans, beat the machines – Manage scale and scope of events affecting portfolio – Risk management and loss avoidance

• Thomson Reuters Machine Readable News
– Historical data to back test and build algorithms – Real-time feeds for deployment, including ultra-low latency feed – Analytic add-ons which convert qualitative text into quantitative data

EXPLOITING NEWS CONTENT
• News flow is a good indicator of volume and volatility. • Pricing movements accompanied by news tend to be momentum in nature; those with a lack of news tend to reverse to average trends. • The market tends to overreact when there is a lot of news on something and under-react when there is a small quantity of news. • For direction and magnitude, find cause:effect relationships

MACHINE READABLE NEWS USE CASES
• Circuit breaker / halt trading alert (Wolf detection) • News flow algorithms (more participatory algos) • Alpha generating signal • Risk Management – Quantify “event risk” and manage portfolio volatility • Compliance – monitor for potential market abuse • Post trade analysis – why did the algo/strategy not work? • Stock screening tool (good/bad news stocks) • Fundamental research – measure company sentiment, peer analysis, aggregate for market/sector outlook • Trader support – confirming/contrarian trading signals, volatility signals

THOMSON REUTERS NEWS ANALYTICS
– Sentiment/author tone – Relevance – Novelty – Volume – Headline analysis

Powered by: an Infonic company

• Linguistic system scores text across a number of primary dimensions

• Sentiment/Tone: Assigns sentiment scores to different words/phrases
– Put into context by part of speech, surrounding words, proximity of words to one another, and other sophisticated linguistic cues – Scores combined to determine prevailing sentiment for a given entity within article - Entity level scoring gives more complete picture

THOMSON REUTERS NEWS ANALYTICS EQUITIES SAMPLE OUTPUT

Relevance: 0 - 1.0 Prevailing Sentiment: 1, 0, -1 Positive, Neutral, Negative: Probabilities which sum to 1.00, providing more granular sentiment Novelty represented by Linked Counts: 12h, 24h, 3d, 5d, 7d Item Type: Alert, Article, Updates, Corrections Headline: Alert or Headline text Topic Codes: What the story is about; RCH=Research; RES=Results; RESF=Results Forecast; MRG=Merger & Acquisitions . . . Other metadata: Index IDs, Linked references, Story Chains (41 total in version 1.0)

THE SCIENCE OF FINDING ALPHA IN NEWS
• News Analytics
– Simple
• Intensity – number of stories, alerts, etc.

– Sophisticated
• Relevance – how much the item is about the company • Sentiment – positive/neutral/negative news • Novelty – uniqueness of items

• Atomic News Events • Aggregate News Events

THOMSON REUTERS NEWS ANALYTICS EVENT STUDIES – PHASE 1
Event Study 1:
S&P1500 over 2008, 75% of items are positive/negative on a day with at least three items Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

42 BPs excess return seen on a 5-day interval if long after good news days and short after bad news days

42 BPs

THOMSON REUTERS NEWS ANALYTICS EVENT STUDIES – PHASE 1
Event Study 1:
S&P1500 over 2008, 75% of items are positive/negative on a day with at least three items Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

212 BPs excess return seen on a 60-day interval if long after good news days and short after bad news days

212 BPs

60

THOMSON REUTERS NEWS ANALYTICS EVENT STUDIES – PHASE 1
Event Study 2:
S&P1500 over 2008, 50% of items are positive/negative on a day with at least 50 items Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Over 800 bps
Over 800 BPs excess return seen on a 1-day interval if long after good news days and short after bad news days

THOMSON REUTERS NEWS ANALYTICS EVENT STUDIES – PHASE 1
Event Study 2:
S&P1500 over 2008, 50% of items are positive/negative on a day with at least 50 items Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Over 5000 BPs excess return seen on a 60-day interval if long after good news days and short after bad news days

Over 5000 BPs

THOMSON REUTERS NEWS ANALYTICS EVENT STUDIES – PHASE 1
Event Study 3:
S&P1500 over 2008, 75% of items are positive/negative on a day with at least 10 items Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

175 BPs excess return seen near-term with reversals appearing – Sell good news and buy bad news the following day? Days 2-10 noise or strategy to lock in 100 BPs?

THOMSON REUTERS NEWS ANALYTICS EVENT STUDIES – PHASE 2 STUDY DESIGN
• Intensity
– How much news on company in particular time period – Thresholds: 1 or 2 unique news items per day minimum

Relevance
– How much the article is about a particular company – >=.6

Sentiment
– Probability that a story is positive, negative or neutral in tone – Average daily sentiment in top 5% or 10%

Novelty:
– How often has a story with similar text to this one appeared? – Linked Count = 0

13

THOMSON REUTERS NEWS ANALYTICS
Event Study 1:
S&P1500 2003-2008, >=1 item, P(POS) & P(NEG) in 90th percentile, linked counts 1-5=0 Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Returns in Excess of SPY (BPs)

Items threshold

Percentile

Excess Return (BPs)

No. of Signals

1

90

24

55996

24 BPs

Days Since Event Date

THOMSON REUTERS NEWS ANALYTICS
Event Study 1:
S&P1500 2003-2008, >=2 items, P(POS) & P(NEG) in 90th percentile, linked counts 1-5=0 Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Returns in Excess of SPY (BPs)

Items threshold

Percentile

Excess Return (BPs)

No. of Signals

1 2

90 90

24 47

55996 10317

47 BPs

Days Since Event Date

THOMSON REUTERS NEWS ANALYTICS
Event Study 1:
S&P1500 2003-2008, >=1 item, P(POS) & P(NEG) in 95th percentile, linked counts 1-5=0 Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Returns in Excess of SPY (BPs)

Items threshold

Percentile

Excess Return (BPs)

No. of Signals

1

95

24

28000

24 BPs

Days Since Event Date

THOMSON REUTERS NEWS ANALYTICS
Event Study 1:
S&P1500 2003-2008, >=2 items, P(POS) & P(NEG) in 95th percentile, linked counts 1-5=0 Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Returns in Excess of SPY (BPs)

Items threshold

Percentile

Excess Return (BPs)

No. of Signals

1 2

95 95

24 67

28000 3282

Days Since Event Date

THOMSON REUTERS NEWS ANALYTICS
Event Study 2:
BASIC MAT (S&P1500) 2003-2008, >=2 items, P(POS) & P(NEG) in 90th percentile, linked counts 1-5=0 Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Returns in Excess of XLB (BPs)

Items threshold

Percentile

Excess Return (BPs)

No. of Signals

1 2

90 90

31 69

3348 685

Days Since Event Date

THOMSON REUTERS NEWS ANALYTICS
Event Study 2:
BASIC MAT (S&P1500) 2003-2008, >=2 items, P(POS) & P(NEG) in 95th percentile, linked counts 1-5=0 Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Returns in Excess of XLB (BPs)

Items threshold

Percentile

Excess Return (BPs)

No. of Signals

1 2

95 95

48 115

1781 236

Days Since Event Date

THOMSON REUTERS NEWS ANALYTICS
Event Study 4:
FINANCIALS (S&P1500) 2003-2008, >=2 items, P(POS) & P(NEG) in 90th percentile, linked counts 1-5=0 Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Returns in Excess of XLF (BPs)

Items threshold

Percentile

Excess Return (BPs)

No. of Signals

1 2

90 90

38 85

8494 1552

85 BPs

Days Since Event Date

THOMSON REUTERS NEWS ANALYTICS
Event Study 4:
FINANCIALS (S&P1500) 2003-2008, >=2 items, P(POS) & P(NEG) in 95th percentile, linked counts 1-5=0 Aggregation window: 3:30pm EST – 3:30pm EST; Position initiated at close

Returns in Excess of XLF (BPs)

Items threshold

Percentile

Excess Return (BPs)

No. of Signals

147 BPs

1 2

95 95

32 147

3897 452

Days Since Event Date

INCORPORATING NEWS INTO MULTIFACTOR MODELS

Nitish Sinha, PhD University of Illinois (Doctoral Work at University of Maryland)

RESEARCH QUESTIONS

• Is momentum driven by underreaction to information? • Is it really possible to make money off information from news? • Can one generate risk adjusted excess return using news?

DATA DESCRIPTION AND STUDY FILTERS
• Data – 2003-2008 – Monthly stock prices, Book value ,Fama French factors, and UMD – Thomson Reuters News Analytics data including sentiment, relevance, novelty • Filter – Positive book to market – Listed for at least a year and covered by Thomson Reuters – Articles only – Relevance > 0.35 – Linked Count < 2

DATA DESCRIPTION (CONTINUED)
• Two dimensions of news – News count – Sentiment • News count is affected by the size of firm – Normalize news count by previous month’s market capitalization – Find the mean and standard deviation of news count – Assign Z-scores

EXAMPLE NEWS COUNT STRATEGY

• Long stocks with a history of usual amount of news • Short stocks with unusual amount of news • Hold position for five months • Generates ~45 basis points per month in excess of Fama French 3 factors and UMD. • Works better for smaller stocks, stocks with positive momentum, and value stocks

ALPHA FROM THE SENTIMENT STRATEGY CONDITIONAL ON MOMENTUM

Monthly Excess Return1

Momentum  Group

1: In excess of Market, HML, SMB, and UMD

SHORT TERM SENTIMENT BASED STRATEGY CONTROLLING FOR MOMENTUM

CONSTRUCTION OF HISTORICAL SENTIMENT

i=1

N

Time

T=‐3 ‐2 ‐1 0

Month

Figure: Aggregation of individual news item to obtain historical sentiment

Why three months? • Higher volume of news during earnings release • Survey by Graham et. al. suggests firms use earnings release to bundle news

LONG TERM SENTIMENT FOR CITI

LONG TERM SENTIMENT WITH MONTHLY RETURNS

NORMALIZED SENTIMENT

Effects on Citi are more pronounced when adjusting for normal market sentiment.

NORMALIZING SENTIMENT INCREASES CORRELATION WITH MONTHLY RETURNS

MONTHLY NET SENTIMENT (NUMBER OF POSITIVE – NUMBER OF NEGATIVES)
S&P500

September, 2008 financial collapse

XLE (Energy)
But overall sentiment turns in October, 2007

Monthly Net Sentiment

THOMSON REUTERS NEWS ANALYTICS VERSION 2.0 EQUITIES SAMPLE OUTPUT

**82 total fields – others include index information, linked item IDs, etc

THOMSON REUTERS NEWS ANALYTICS DELIVERY OPTIONS
• Hosted in Elektron – leased line or VPN delivery • Deployed at customer site
– Customer specific configurations – Customer content or additional feeds

• DataScope Select Delivery (beta Sept, 2010) • Daily updates via TRQA (FasTick API) • Historical files for testing via customer zone and TRQA

Questions?
For further information, please contact your Thomson Reuters sales representative or email MRN@thomsonreuters.com

Bedtime reading: • News Analysis Research Guide • Signal Processing: Beyond the Headlines, Deutsche Bank, 7/19/2010 • Relating News Analytics to Stock Returns, Leinweber & Sisk, 1/2010 • Managing Real-Time Risks and Returns: The Thomson Reuters NewsScope Event Indices, Healy and Lo, 8/2010

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