The Handbook of News Analytics in Finance

13.5 DISCUSSION AND CONCLUSIONS

In this chapter we address the problem of making equity portfolio risk estimates sensitive to changes in the market environment and investor sentiment. Traditional multifactor risk models fail to update quickly as new information becomes available. diBartolomeo and Warrick (2005) use option-implied volatility to determine improved estimates of the future covariance matrix. There is a strong, yet complex relationship between market sentiment and news. Traders and other market participants digest news rapidly and update their asset positions accordingly. However, for models to incorporate news directly and automatically, we require quantitative inputs, whereas raw news is qualitative data. RavenPack has developed linguistic analytics that process the textual input of news stories to determine quantitative sentiment scores.

To the extent that we are interested in risk estimation over a relatively short future horizon, conventional factor model methods of estimating security and portfolio risk can be made more responsive to changing conditions by conditioning the forecasts on changes in implied volatility and quantified news. We have presented a tractable method of including both option-implied volatility and quantified news into portfolio risk estimation.

While much research remains to be done to refine our methods, frequent crises in financial markets remind us of the urgency with which all investors, even those with a long-term orientation, should ...