Separating the signal from the noise – Financial machine learning for Twitter

Matthias Schnaubelt, Thomas G. Fischer and Christopher Krauss

Journal of Economic Dynamics and Control, 2020, vol. 114, issue C

Abstract: Most statistical arbitrage strategies in the academic literature solely rely on price time series. By contrast, alternative data sources are of growing importance for professional investors. We contribute to bridging this gap by assessing the price-predictive value of millions of tweets on intraday returns of the S&P 500 constituents from 2014 and 2015. For this purpose, we design a machine learning system addressing specific challenges inherent to this task. At first, building on the literature of financial dictionaries, we engineer domain-specific features along three categories, i.e., directional indicators, relevance indicators and meta features. Next, we leverage a random forest to extract the relationship between these features and subsequent stock returns in a low signal-to-noise setting. For performance evaluation, we run a rigorous event-based backtesting study across all tweets and stocks. We find annualized returns of 6.4 percent and a Sharpe ratio of 2.2 after transaction costs. Finally, we illuminate the machine learning black box and unveil sources of profitability: First, results are both driven and limited by the temporal clustering of tweets, i.e., the majority of profits stem from tweets clustered closely together in time, corresponding to high-event situations. Second, the importance of included features follows an economic rationale, e.g., tweets with positive sentiment tend to yield positive returns and vice versa. Third, we find that stocks of medium market capitalization and from the consumer and technology sectors contribute most to our results, which we interpret as a trade-off between tweet coverage and tweet relevance.

Keywords: Finance; Statistical arbitrage; Machine learning; Natural language processing (search for similar items in EconPapers)
JEL-codes: C55 G11 G14 G17 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:114:y:2020:i:c:s0165188920300634

DOI: 10.1016/j.jedc.2020.103895

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