Stress index strategy enhanced with financial news sentiment analysis for the equity markets

TL;DR

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Abstract

This paper introduces a new risk-on risk-off strategy for the stock market, which combines a financial stress indicator with a sentiment analysis done by ChatGPT reading and interpreting Bloomberg daily market summaries. Forecasts of market stress derived from volatility and credit spreads are enhanced when combined with the financial news sentiment derived from GPT-4. As a result, the strategy shows improved performance, evidenced by higher Sharpe ratio and reduced maximum drawdowns. The improved performance is consistent across the NASDAQ, the S&P 500 and the six major equity markets, indicating that the method generalises across equities markets.

Figures (15)

• Figure 1: Comparison of the dynamic strategy combining Stress index and News and Stress index alone using persistence of overperformance of one strategy over the other one versus the naive long only strategy (rescaled at the same volatility) for the S&P 500 universe. The first plot compares the two strategies over time while the subplot provides the corresponding overall allocation.
• Figure 2: Comparison of the dynamic strategy combining Stress index and News and Stress index alone using persistence of overperformance of one strategy over the other one versus the naive long only strategy (rescaled at the same volatility) for the NASDAQ 100 universe. The first plot compares the two strategies over time while the subplot provides the corresponding overall allocation.
• Figure 3: Comparison of the dynamic strategy combining Stress index and News and Stress index alone using persistence of overperformance of one strategy over the other one versus the naive long only strategy (rescaled at the same volatility) for the Major Equities Markets. The first plot compares the two strategies over time while the subplot provides the corresponding overall allocation.
• Figure 4: Comparison of the strategy based only on news versus the naive long only strategy (rescaled at the same volatility) for the S&P 500 universe. The first plot compares the two strategies over time while the subplot provides the corresponding overall allocation.
• Figure 5: Comparison of the strategy based only on news versus the naive long only strategy (rescaled at the same volatility) for the NASDAQ 100 universe. The first plot compares the two strategies over time while the subplot provides the corresponding overall allocation.