A Tale of Two Sentiment Scales: Disentangling Short-Run and Long-Run Components in Multivariate Sentiment Dynamics

37 Pages Posted: 4 Oct 2019 Last revised: 8 Sep 2020

See all articles by Danilo Vassallo

Danilo Vassallo

Scuola Normale Superiore

Giacomo Bormetti

University of Bologna - Department of Mathematics

Fabrizio Lillo

Università di Bologna

Date Written: October 3, 2019

Abstract

We propose a novel approach to sentiment data filtering for a portfolio of assets. In our framework, a dynamic factor model drives the evolution of the observed sentiment and allows to identify two distinct components: a long-term component, modeled as a random walk, and a short-term component driven by a stationary VAR(1) process. Our model encompasses alternative approaches available in literature and can be readily estimated by means of Kalman filtering and expectation maximization. This feature makes it convenient when the cross-sectional dimension of the portfolio increases. By applying the model to a portfolio of Dow Jones stocks, we find that the long term component co-integrates with the market principal factor, while the short term one captures transient swings of the market associated with the idiosyncratic components and captures the correlation structure of returns. Using quantile regressions, we assess the significance of the contemporaneous and lagged explanatory power of sentiment on returns finding strong statistical evidence when extreme returns, especially negative ones, are considered. Finally, the lagged relation is exploited in a portfolio allocation exercise.


Keywords: Sentiment Analysis; Dynamic Factor Models; Kalman FIlter; Expectation Maximization; Quantile Regression

Suggested Citation

Vassallo, Danilo and Bormetti, Giacomo and Lillo, Fabrizio, A Tale of Two Sentiment Scales: Disentangling Short-Run and Long-Run Components in Multivariate Sentiment Dynamics (October 3, 2019). Available at SSRN: https://ssrn.com/abstract=3463691 or http://dx.doi.org/10.2139/ssrn.3463691

Danilo Vassallo (Contact Author)

Scuola Normale Superiore ( email )

Piazza dei Cavalieri, 7
Pisa, 56126
Italy
+393312732394 (Phone)

Giacomo Bormetti

University of Bologna - Department of Mathematics ( email )

Piazza di Porta S. Donato , 5
Bologna, Bologna 40126
Italy

Fabrizio Lillo

Università di Bologna ( email )

Via Zamboni, 33
Bologna, 40126
Italy

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