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1 June 2016 CFA Institute Journal Review

Rumor Has It: Sensationalism in Financial Media (Digest Summary)

  1. Peter Eickelberg, CFA

Financial media are incentivized to seek out sensational rumors relating to takeovers of newsworthy firms. By considering a journalist’s experience and characteristics, investors can better judge the accuracy of a rumor. Less accurate rumors tend to include hedged language. Markets may initially overreact to rumors but will tend to reverse—except when factors that help identify accurate rumors exist.

What’s Inside?

The authors’ goal is to determine which characteristics of media articles might predict the accuracy of a rumor, and they consider whether investors properly account for these characteristics. Articles about merger rumors are characterized by the journalist’s biographical traits, the prominence of the newspaper, the newsworthiness of the target company, and specific language markers. The authors find that older, more experienced journalists and those with specific industry education provide more accurate reporting. In contrast, the target company’s newsworthiness correlates with inaccurate rumors. Less accurate rumors also often include hedged language and lack specific datapoints.

How Is This Research Useful to Practitioners?

Consumers of the financial press intuitively understand that newspapers aim to get their attention. Still, an empirical analysis of how much media incentives can bias coverage could prove useful to someone relying on the news for making tactical allocations, buy/sell decisions, or business plans.

Other research has suggested that the media structure their coverage of financial news to grab investor attention. The authors find confirming evidence for articles pertaining to merger rumors because coverage is biased toward well-known firms but is generally later shown to be false. They show that investors fail to fully account for this bias, producing a price overreaction and subsequent reversals, which is consistent with theories about investors’ limited attention spans.

The authors also find that journalist biographical information (e.g., age, academic training, and industry experience) improves the chances that a rumor is accurate. But investors fail to take this information into account when evaluating the accuracy of the rumor. A hedge fund manager in the merger and acquisition space would especially want to develop a detailed knowledge of which factors correlate with rumors that turn out to be accurate. As such, it would be important to know relevant biographical details before relying on a journalist’s work.

More narrowly, traders who work with stocks that are the subject of merger activity should understand how the market tends to overreact to as well as discount merger rumors.

How Did the Authors Conduct This Research?

Using a set of search terms, the authors identified “scoop” articles from the Factiva database that contain the first-known public mention of a target takeover rumor. Their sample includes more than 500 rumors covering more than 350 companies between 2000 and 2011.
The authors then review target company names for newsworthiness, relying on a definition that includes breadth, proximity to the readership, and prominence in the industry. This analysis reveals that up to 90% of the rumors deal with large, well-known companies. The authors note that many actual mergers do not receive any news coverage at all.
Rumor “accuracy” is achieved when a proposed merger takes place within one year of the rumor’s publication, irrespective of the acquirer. The authors also check for robustness using alternate definitions of accuracy.
The authors perform logit regressions using variables describing target newsworthiness, journalist characteristics, textual markers, and newspaper characteristics. A database of actual mergers is used as a control group to help determine whether certain types of firms receive more rumor coverage. Other control variables include journalist gender, staleness of the rumor, year, and industry.
Target stock returns are regressed against their relevant CRSP index for set periods of time to test whether stocks that are subject to inaccurate rumors perform differently from those about which an accurate rumor is published. In fact, although both types of stocks run up when a rumor is announced, stocks subject to inaccurate rumors tend to reverse more completely.

Abstractor’s Viewpoint

Financial professionals will readily grasp how incentives in the media drive reporting behavior. This study provides a more complete understanding of which factors to focus on when reviewing articles that contain rumors. Given that less well-known firms do not receive much or any coverage and that rumors regarding large firms tend to be false, there could be buying as well as short-selling opportunities for the dedicated analyst. Some discussion centers on investors’ limited attention spans and tendency not to investigate the facts surrounding a rumor. Knowing which factors relate to rumor accuracy might help client-facing professionals navigate individual investor excitement successfully.

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