The Handbook of News Analytics in Finance

10.1 INTRODUCTION

News is information that describes how the state of the world is somehow different than the state of the world usually is. With this simple concept as a foundation, it is possible to dramatically improve the assessment of financial market risk for both financial intermediaries and asset owners. Like most things, the level of risk in financial markets can be thought of as being like it usually is, except when it is not. Through the incorporation of news into our formal models, we can rapidly recognize, understand, and respond to periods of heightened risk, as have been experienced in the financial global crisis of the past two years.

Whenever we speak about assessment of financial market risk, we must begin by identifying some key elements. What metrics of risk are we interested in describing? We will use symmetric measures such as the expected standard deviation of asset returns, or some measure of potential loss such as conditional “Value at Risk” (CVAR). Will our risk measures consider risk in the context of absolute gain or loss, or rather consider investment return and risk relative to some benchmark index? Should our metric for risk depend solely on the fractional composition of our investment portfolio, implicitly assuming unlimited liquidity in the trading of assets, or should the metric explicitly incorporate the potential for illiquid market conditions?

Perhaps the most vexing question, and the one to which news has the most conceptual relevance is time ...