The Handbook of News Analytics in Finance

11.1 INTRODUCTION

When prices drop, volatility increases. This general observation was most noticeable during the recent Credit Crisis, where—following stock market drops—volatility reached record values. The effect has been most widely explained by changes in leverage and the existence of time-varying risk premiums. It is therefore sometimes called the “leverage effect”, but we will use the more neutral name volatility asymmetry, since so far no clearly recognized explanation exists.

In this chapter we investigate the potential relation between the occurrence of volatility asymmetry, news, and private investors. In Section 11.2 we summarize the results from a study comparing volatility asymmetry in 49 countries worldwide (Talpsepp and Rieger, 2009). The study shows that volatility asymmetry is most pronounced in highly developed markets and, in particular, in markets with high participation of private investors. Moreover, we find that markets with many financial analysts actually show higher volatility after downturns. These results suggest that private investors might react nervously to bad news. We show that times of high news concentration are typically times of many bad news, thus the overreaction of private investors to bad news will likely lead to the observed asymmetry in volatility.

Further evidence for this relationship between news, private investors, and volatility asymmetry is reported in Section 11.3.1, which discusses volatility of the S&P 500 increases after an ...