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Draft: November 2008 The Effect of Macroeconomic News on Stock Returns: New Evidence from Newspaper Coverage Gene Birz Department of Economics State University of New York at Binghamton Binghamton, NY 13902-6000 gbirz1@binghamton.edu John R. Lott, Jr. University of Maryland Foundation University of Maryland College Station, MD 20742 jlott@umd.edu Abstract In this paper we choose a different approach of measuring real sector macroeconomic news to better estimate its effect on stock returns. Pr
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   Draft: November 2008 The Effect of Macroeconomic News on Stock Returns:New Evidence from Newspaper Coverage Gene BirzDepartment of EconomicsState University of New York at BinghamtonBinghamton, NY 13902-6000gbirz1@binghamton.edu   John R. Lott, Jr.University of Maryland FoundationUniversity of MarylandCollege Station, MD 20742 jlott@umd.edu Abstract In this paper we choose a different approach of measuring real sector macroeconomicnews to better estimate its effect on stock returns. Previous literature has produced weak evidence to support the hypothesis that real economic news affects stock returns. This is,in part, attributed to the difficulty of measuring how investors interpret macroeconomicnews, as captured by the statistical releases on economic variables. Since newspaperheadlines provide an interpretation of the statistical releases, we choose Lott and Hassett(2006) headlines classification as our measure of news. Our findings indicate that newson GDP and unemployment does affect stock returns.  2 I. Introduction The last three decades of finance research have produced a tremendous number of papers examining the effect of news announcements on financial markets. While manyof these papers study the effect of firm-specific news, others explore a theoreticallyappealing idea that financial markets react to macroeconomic news. Asset pricing theoryargues that any variable that affects the level of consumption or the investmentopportunity set should be priced in the equilibrium, thus making macro announcementsexcellent candidates to correlate with stock returns [Merton (1973), Breeden (1979)].However, stock market effects of macroeconomic factors are hard to find empirically.Previous studies have found the effects of news about money growth and interest ratevariables on stock prices. 1 But evidence for stock price effects of news about statistics onreal variables such as GDP, unemployment, durable goods orders, and others, is mixed.One difficulty in finding these effects comes from the fact that it is hard tomeasure the component of the statistical release relevant for stock prices. According toefficient market hypotheses, stock prices already incorporate all existing and expectedpublic information and should only respond to new information. Thus, to capture newinformation in the economic releases, previous papers calculated economic surprises of the releases, measured by the difference between the release and financial marketparticipants’ previous expectations of the release, as revealed by surveys. This differencewould then represent unanticipated, new information about economic conditions and, if different from zero, should lead to a change in stock prices. For example, GDP growth 1 Previous research found a statistically significant relationship between stock returns and interest ratevariables such as short-term interest rates [Chen (1991)], term structure measured by the spread betweenlong- and short-term interest rates [Chan, Karceski and Lakonishok (1998), Chen, Roll and Ross (1986),Campbell (1987)], and yield spreads between high and low grade bonds [Chen, Roll and Ross (1986), Chan,Chen and Hsieh (1985)]. In addition, studies found strong evidence of money growth affecting stock returns [Cornell (1983), Pearce and Roley (1983, 1985)].  3rate higher than expected would lead investors to expect good economic conditions in thefuture, which would raise the demand for securities and raise security prices.Another difficulty is that the interpretation of the release is another determinant of investors’ expectations and, therefore, a determinant of stock prices as well. In otherwords, investors form expectations based on their interpretation of the statistical releasesof macroeconomic variables, which then affect their demand for securities and leads tochanges in stock prices. For example, GDP growth rate higher than expected can beinterpreted as “good news” for stock prices in recessions but “bad news” in expansions[McQueen and Roley (1993)]. This finding can be explained by the fact that high GDPgrowth rate in recessions can be interpreted by investors as a sign of economicimprovement and lead to higher stock prices. Alternatively, the same high GDP growthrate in expansions can lead to investors’ expectations of a contractionary monetary policyresulting in higher interest rates and, therefore, leading to lower stock prices.In this paper, we choose a different approach to find the relationship betweenmacroeconomic factors and stock prices. We use newspaper headlines to measuremacroeconomic news because headlines represent an interpretation of the statisticalreleases and can, therefore, be a good indicator of investors’ expectations about theeconomy. Newspaper articles often provide a detailed discussion of the economic reportsby analyzing all the potential implications. However, a final conclusion about whetherthe release overall represents “positive” or “negative” economic news is captured by theheadlines. This type of interpretation is then a good indicator of investors’ expectationsabout future economic conditions. For example, in response to GDP release, on January31, 2004, a headline in the  New York Times was, “Economy Remained Strong in 4thQuarter, US Reports.” This headline interprets the GDP release as positive news andinforms the readers about good economic conditions. On February 16, 1996, Palm Beach  4 Post’s headline in response to the release of durable goods orders read, “Reports IndicateEconomy Could Be Heading for Stall.” This particular headline concludes that thedurable goods report signals bad economic conditions.The headlines data were obtained from Lott and Hassett (2006), who examinewhether media coverage of economic announcements depends on the party affiliation of the president. The dataset was created for nonfinance-related study, which contributes tothe unbiasness of our study. Lott and Hassett (2006) collect all headlines related tomacroeconomic releases and employ an unbiased research team to classify each headlineas positive, negative, mixed, or neutral. Since a newspaper headline is the interpretationof the data releases, then Lott and Hassett (2006) classification should be able to capturewhether the statistical release represents “good news” or “bad news,” which is whatmatters for investors’ expectations about future economic conditions. We examine fourmacroeconomic variables, specifically GDP Growth, Unemployment Rate, Retail Sales,and Durable Goods, and find that news on GDP and Unemployment does affect stock returns.The remainder of the paper is organized as follows. Section II will provide amore detailed discussion of theory and previous work. Section III will describe the data.We will discuss our empirical results in Section IV. Finally, Section V will conclude. II. Theory and Existing Research The channel by which macro news affects stock returns can be shown through thefundamental definition of the price of a security:  = ∑ + ∞=++ 1 1 τ  τ  τ   k C P t t t   E 

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