Does the choice of words in the Fed’s board of Governors’ speeches matter?

Abstract

Yes it does. The US stock market index shows significant statistical association with the tone of Fed speeches on the day the speech is delivered. We find that negative speeches depress returns and amplify volatility. The stock market moves more strongly in response to forward-looking speeches, and to speeches whose tone is negative. We capture financial texts’ tone better than current techniques due to two innovations introduced in this study: i) a sentence-based ngram analysis that quantifies the connotation of multi-clausal phrases (e.g., ‘a slowdown in business profitability’); and ii) usage of an augmented financial dictionary which incorporates ‘valence shifters’: adjectives, adverbs and conjunctions (such as ‘large’, ‘slightly’, ‘although’ etc.) which alter the connotation of text but have been ignored in financial text analysis. We show that valence shifter usage in Fed speeches is the highest during the Great Recession and the Eurozone debt crisis.