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Turn agenda setting theory into alpha opportunity

What is agenda setting bias or theory? Why does agenda-setting bias matter to investment management firms and hedge funds when making trading choices or managing risk? How can financial market participants overcome or mitigate this agenda setting bias?

What is agenda setting theory?

The agenda setting theory was first presented by Maxwell McCombs in 1972. The theory holds that issues emphasized by the media will directly influence the public’s perception of which issues are most important. The relevance of this phenomenon combined with the breadth and reach of today’s 24/7 always on news cycle has significantly increased. In the business world this agenda setting theory is still being fleshed out; however, its relevance is immediately obvious. As stated in Agenda-setting Effects of Business News on the Public’s Images and Opinions about Major Corporations:

There has been tremendous growth in the volume of business news appearing in the mass media during recent decades. The New York Times business journalist Diana Henriques (2000) notes that coverage of the New York Stock Exchange and NASDAQ, for example, has doubled in the last ten years of the 20th century.” – Craig E Carroll

A doubling in volume of news for NYSE and NASDAQ traded companies provides a large enough challenge for integration of text based unstructured data into the entire investment management process. Addressing the secondary effect of any agenda-setting bias in the news is a wholly unique challenge nearly equal in scope to the increased volume of business news.

Why is agenda setting theory important in the financial markets?

Now that we know what agenda-setting bias is and have a cursory understanding of the tremendous amount of business news, which continues to grow daily; let us turn our attention to why addressing this ability of the media to essentially influence the balance of opinion on topics toward a certain outcome is of crucial importance when making investment decisions. Again we turn to Craig E Carroll’s paper which discusses the two levels of media participation. The first level is the mere decision of which topics (we can think of topics as companies in this case) to present to the public. This level can be the most challenging to overcome when making investment decisions. If a company or topic is not covered in media then other sources of data most be discovered. This can be done by analyzing the textual content of regulatory filings or analyst reports (which may still be subject to agenda setting bias but can be considered distinct from general media). The second level of influence as discussed by Carroll are the attributes assigned to the topic. In business news these attributes are the tone or sentiment that is used in presenting the news around a given company or topic. The Why for addressing side-effects of agenda setting theory becomes clear as we see the two level impact that media can have on financial market news.

How can market participants turn agenda setting theory into alpha opportunity?

Finally there is the question of how can agenda setting theory effects be mitigated and even capitalized on in the financial markets? As already discussed alternate sources of text data such as analyst reports or regulatory filings and even corporate materials can be analyzed to enrich the entire set of available sources of data. By integrating these additional sources, level one of the media bias can be mitigated. More powerfully, sentiment or attributes analysis can be done across all textual data sources including media/business news sources. Performing this sentiment analysis in a repeatable, insightful and actionable manner provides a mechanism to normalize and quantitatively identify possible forms of second level agenda setting. By compiling and integrating into the entire investment process a real-time news analysis engine – hedge funds and investment firms can successfully identify trends, discover data asymmetry and alpha opportunity in the market. Transforming the ultimate big data set, global business news, through sentiment analysis into actionable quantitative insight and creating the opportunity to mitigate or at least identify any media bias can lead to significant alpha generating capability.

For further reading on agenda setting theory: