Three Essays on The Application of Behavioural Finance and Textual Analysis to Financial Markets

Abstract

This thesis comprises three chapters. The first, 'Retail investor attention & its effect on stock price reactions to news', describes the impact of individual investor attention on stock market mispricing of news. We found that mispricing is more prevalent after negative news as a result of high abnormal retail attention, in contrast to a prediction from limited attention theory that investor attention reduces stock mispricing and improves market efficiency. Using Google Search volumes as a proxy for investor attention, we found that high unexpected search queries for a target firm do not demonstrate that investors are focusing on firm-specific information. Rather, unusual search volumes may be driven by greater investor uncertainty or the participation of less-informed retail investors, leading to a stronger market underreaction to negative news. We also found that the characteristics of firms with high retail investor attention (small size, low institutional ownership, high analyst dispersion, high idiosyncratic volatility and high short interest) are indicators of market inefficiency and are negatively associated with the speed of information diffusion.

The second chapter, 'MD&A disclosure & investors' reactions to management forecasts', shows that the Management Discussion and Analysis (MD&A) disclosure in the 10-K report may affect price reactions to management forecast news. The study extracted MD&A sections from 10-K reports and used readability, uncertainty and tone change to capture the quality of MD&A disclosures using an approach developed by Loughran and McDonald (2011). Our findings suggest that these factors influence the price reaction to management forecasts and that the price underreaction, measured as the post-announcement cumulative abnormal return, is significantly associated with MD&A readability and uncertainty. We found that the market reaction to management forecasts was stronger for firms with more uncertain, less readable and more optimistic MD&A disclosures. The price underreaction to management forecast news was stronger for firms with more uncertain and less readable disclosures. We found evidence for a positive relation between MD&A readability and forecast precision, indicating that managers' motives to reduce information asymmetry by issuing clear disclosures align with their motives to enhance forecast precision.

The third chapter, 'How global sentiment affects A-H cross-listed share mispricing in China: mechanisms of global sentiment contagion in a segmented market,' investigates the impact of global and local sentiment on China's A-H cross-listed stock price spread using market accessibility to global investors and risk exposure. The study aimed to provide a global sentiment-driven explanation of A-H price disparities. We investigated how policy options for Chinese equity markets to integrate into international financial markets affected sentiment effects on A-H premiums. We found that the relaxation of foreign ownership restrictions mitigated the negative impacts of global sentiment on A-H price disparities. We also identified the channel of global sentiment contagion in driving portfolio investment. Finally, we found that the higher relative arbitrage costs for A-shares amplify the negative impacts of global sentiment on A-H premiums, indicating an asymmetric influence of global sentiment across different levels of relative arbitrage risk.