Wisdom of the Crowds: The Value of Stock Opinions Transmitted Through Social Media
- Hailiang Chen, Prabuddha De, Yu Jeffrey Hu, Byoung Hyoun Hwang
- Review of Financial Studies, 2014, vol. 27, no. 5, pages 1367-1403.
- A version of this paper can be found here
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What are the research questions?
- Do peer opinions impart value-relevant news or are they merely random chatter (value-relevance hypothesis)?
- Do peer opinions predict subsequent earnings surprises?
What are the Academic Insights?
By employing textual analysis (focusing on the fraction of negative words both in SA articles and follow-up comments), the authors study user-generated opinions from Seeking Alpha (SA) on a sample of more than 7,000 companies during 2005-2012 and find the following:
- YES- views expressed on SA are generally confirmed by subsequent stock market performance. Future abnormal returns are 0.38% lower when the fraction of negative words in SA articles is 1% higher and 0.19% lower when the fraction of negative words in SA comments is 1% higher. This prediction holds over different investment horizons and they tend to increase with the length of the holding period.
- YES- views expressed on SA are generally confirmed by subsequent earnings further below market expectations as measured by financial analysts'forecasts.
The authors perform a number of robustness checks like the inclusion of control variables reflecting analyst recommendation upgrades/downgrades, positive/negative earnings surprises and the negative fraction of negative words in the DJNS articles.
Why does it matter?
With the usual caveat that sample size is limited, this study adds to the literature studying the usefulness of the internet as a source of valuable information and specifically, the usefulness of peer-based advice in financial markets.
The Most Important Chart from the Paper:
Social media has become a popular venue for individuals to share the results of their own analysis on financial securities. This paper investigates the extent to which investor opinions transmitted through social media predict future stock returns and earnings surprises. We conduct textual analysis of articles published on one of the most popular social-media platforms for investors in the United States. We also consider the readers’ perspective as inferred via commentaries written in response to these articles. We find that the views expressed in both articles and commentaries predict future stock returns and earnings surprises.