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# **I.** **<u>Introduction</u>**

The amount financial and economic news has increased dramatically over the past 20 years. The rise of real time news-wire such as Reuters and Bloomberg has also greatly increased the speed at which news travel across the world. Beyond providing information, journalists also choose to portray events related to asset market variations using tonal words that could intrinsically affect investors’ investment decisions. This paper explores the impact of such media sentiment on equity prices.

Using more than 4.5 million Reuters articles published across the globe between 1991 and 2015, we find that news tone – our measure of news sentiment - robustly predicts daily returns in both advanced and emerging markets, even after controlling for known determinants of stock prices. However, not all news has the same impact. Local (countryspecific) news optimism (or pessimism) only affects equity returns temporarily, i.e. for a few days. By contrast, changes in global news sentiment have a larger impact on equity returns around the world that does not reverse in the short run, suggesting a novel and arguably stronger source of sentiment-driven asset price fluctuations. Combining our news sentiment indices with daily equity flows from mutual funds investing in sixteen EMs between 2007 and 2015, we find an effect strikingly close to that of stock returns: although local news optimism attracts equity flows for a few days only, global sentiment optimism attracts them permanently. However, this effect is driven by the (net) asset demand of foreign funds domiciled outside of the country rather than local funds domiciled in the country, suggesting that news tone affects prices mostly through its effect on foreign investors’ sentiment.

Our paper is constructed as follows. Using the fraction of positive and negative words in each article to capture the tone of news published, we first construct a daily news-based sentiment index for 25 advanced and emerging countries between 1991 and 2015. We then estimate the response of equity prices to sentiment shocks using Jordà’s (2005) local projection method. We first estimate the effect of US news sentiment on US equity returns and compare our results to existing studies on the US such as Tetlock (2007). We then test whether these results extend to all countries, after controlling for known sources of predictability in international equity returns, both locally and globally (e.g. commodity prices, VIX etc.). Overall, we find panel estimates to be close to the US benchmark. Positive sentiment shocks also imply a significant impact on equity returns of 10 basis points that partially reverses after a few days, confirming that the effect of news sentiment on asset prices is a pervasive phenomenon that is not limited to the US.

Since a large fraction of news articles in our corpus refer to multiple countries, we then explore whether sentiment shocks are mainly driven by local (country-specific) news, or by global news having an impact on a country. To isolate the effect of local news from that of global news, we start by recomputing the daily sentiment index for each country after having excluded articles that mention any other country than the country of interest, allowing us to