More than Words: Twitter Chatter and Financial Market Sentiment

TL;DR

This paper introduces a Twitter-based financial sentiment index that correlates with market conditions, predicts stock returns, and forecasts monetary policy shifts, offering a novel real-time gauge of financial sentiment.

Contribution

It develops the Twitter Financial Sentiment Index (TFSI) and demonstrates its predictive power for stock returns and monetary policy changes.

Findings

TFSI correlates highly with bond spreads and financial conditions.

Twitter sentiment predicts next-day stock returns.

Sentiment deterioration forecasts monetary policy shocks.

Abstract

We build a new measure of credit and financial market sentiment using Natural Language Processing on Twitter data. We find that the Twitter Financial Sentiment Index (TFSI) correlates highly with corporate bond spreads and other price- and survey-based measures of financial conditions. We document that overnight Twitter financial sentiment helps predict next day stock market returns. Most notably, we show that the index contains information that helps forecast changes in the U.S. monetary policy stance: a deterioration in Twitter financial sentiment the day ahead of an FOMC statement release predicts the size of restrictive monetary policy shocks. Finally, we document that sentiment worsens in response to an unexpected tightening of monetary policy.