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Why Stock Gurus Warn?

Posted in Animal Spirits, Investing Expertise

Does a need to attract attention distort the information offered by online stock bloggers? Does competition among them suppress or amplify this distortion? In their November 2014 paper entitled “Guru Dreams and Competition: An Anatomy of the Economics of Blogs”, Yi Dong, Massimo Massa and Hong Zhang investigate whether: (1) stock bloggers are informative; and, (2) competition among them enhances the quality of information provided. They start by relating blog activity to two proxies for informed versus liquidity trading. They then test the relationship between future stock returns and blog tone, with focus on tone extremism. Finally, they assess the impact of competition among stock bloggers, defining blog activity as competitive when the number of bloggers covering a stock is among the top fourth across all stocks. Using a hand-collected sample of blog articles covering S&P 1500 stocks during 2006 through 2011, they find that:

  • The number of blog articles in the sample grows from only 3,304 in 2006 to 233,040 in 2011.
  • On average, bloggers are informed and somewhat able to predict risk-adjusted stock performance.
    • Blog activity relates positively (negatively) to measures of informed (liquidity) trading.
    • Net blog tone relates positively to next-month abnormal stock performance. A one standard deviation increase in net blog tone indicates a 3.3% higher annualized future abnormal return.
    • Positive (negative) blog tone separately indicates positive (negative) future abnormal returns.
    • Net blog tone retains return predictive power after controlling for net tone of the four largest U.S. newspapers and for analyst recommendations, suggesting that bloggers disseminate some unique information.
  • Competition for attention distorts rather than increases the value of blogger information via an exaggerated negative tone component that does not predict future returns.
    • Specifically, competition drives net blog tone 15% in the negative direction, all due to stronger negative opinions.
    • This negative bias occurs mostly among stocks with high public attention (high analyst coverage, better governance and membership in the S&P 500).

In summary, evidence suggests that stock bloggers are inherently informative, but competition among them induces negative bias via extreme negative commentary that does not enhance informativeness.

Cautions regarding findings include:

  • The methods of measuring blog informativeness are abstract compared to simple comparison of recommendations and returns. These methods are problematically complex for many investors.
  • Reported return calculations are gross, not net. Accounting for frictions associated with trading on monthly blogger tone would reduce these returns.

See also “Why Gurus Go to Extremes”“Guru Grades” and “A Sign of All Times…”.

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