Media spotlight does not drive the Volatility effect in equities

Media spotlight does not drive the Volatility effect in equities

26-06-2019 | Investigación
Investors’ appetite for stocks frequently mentioned in the news is often raised to explain the Volatility effect. But our empirical analysis shows this theory holds little water.
  • David Blitz
    Head of Quant Research
  • Pim  van Vliet, PhD
    van Vliet, PhD
    Head of Conservative Equities and Quant Allocation
  • Laurens Swinkels
  • Rob Huisman

Speed read

  • We analyze whether high media coverage could explain the Volatility effect
  • We find the Volatility effect is present regardless of media coverage
  • Stocks that attract a lot of news attention do not have lower future expected returns

One of the main assumptions of the capital asset pricing model (CAPM) is that complete information is always available to investors and that they process this information in a rational way. The truth, however, is that investors only have limited information. Instead of searching for all the information on every possible company, they often only buy the stocks of companies that grab their attention.

In a paper1 published back in 2008, Brad Barber and Terrance Odean developed the concept of an ' ‘attention-grabbing’ effect. They found empirical evidence that individual investors are more likely to buy stocks that have been in the news. In an earlier paper2 published in 1996, Eric Falkenstein found that mutual funds prefer holding stocks of companies that had featured frequently in the news in the previous year.

Testing the effect of ‘attention-grabbing’ on stock prices

This behavior of both individual investors and fund managers suggests that the prices of attention-grabbing stocks tend to be temporarily inflated, which subsequently leads to lower-than-expected returns. Meanwhile, stocks that are not featured frequently in the news are more likely to be underpriced, which then leads to higher-than-expected returns.

Can the low volatility be explained by the ‘attention-grabbing’ theory?

It is easy to conclude from this that more volatile stocks that feature more frequently in the news and grab investors’ attention have lower expected returns relative to the market as whole. And, therefore, that the low volatility anomaly can – at least partially – be explained by the ‘attention-grabbing’ theory3. But is that really the case?

To find out, we tested two hypotheses using data on the 3,000 largest stocks in developed markets between January 2001 and December 2018. First, we investigated whether the volatility effect can be found in stocks that are mentioned frequently in the media. We then analyzed whether the low returns seen for high-volatility stocks are caused by frequent media coverage for these stocks.

Two hypotheses rejected

Our calculations show that media coverage does indeed tend to be higher for stocks in higher-volatility groups and volatility is higher for groups of stocks more frequently in the news. In other words, ‘glittery’ stocks tend to be the stocks with relatively high volatility, while the ‘boring’ stocks that the media does not write about tend to be less volatile.

However, we found clear evidence of the volatility effect even among stocks with the highest media coverage. We also found that the most negative returns in the group of most volatile stocks tend to be achieved by those with low media coverage, not by those with high media coverage. Therefore, we reject the two hypotheses tested and conclude that the volatility anomaly cannot be explained by the ‘attention-grabbing’ theory.

1Barber, B.M. and Odean, T., (2008) ‘All that glitters: The effect of attention and news on the buying behavior of individual and institutional investors’, The Review of Financial Studies.
2Falkenstein, E., (1996), ‘Preferences for stock characteristics as revealed by mutual fund portfolio holdings’, The Journal of Finance.
3Note that the ‘attention grabbing’ hypothesis only considers the number of appearances in the news, not the sentiment about a company that is expressed in the news. For more on the latter, see Marchesini, T. and Swinkels, L., (2019), ‘Including news sentiment in quant equity strategies’, Robeco Article. Available on request.