Efficient Markets News Of The Day

Author:
Updated:
Original:

We live in a golden age of information dissemination and stock liquidity, in which news moves faster than earthquakes and high-frequency-trading robots can trade faster than you can blink, meaning that the next time there’s an earthquake your 401k will have bought construction stocks and Twitter even before you stop shaking.

But we’re also living in a golden age of misinformation, where you can find someone to publish pretty much any rumor you want, and those rumors can move markets up or down instantly. And for some reason the robots who've been put in charge of markets seem to be not dispassionate calculating machines but rather touchy C-3PO types, and can exacerbate the speed and severity of crashes with their hypersensitivity. But the upside should be that the recovery from millisecond crashes should be similarly quick – once misinformation is corrected, the robots should dry their tears, blow their noses, and bid prices back up in a few more milliseconds.

Maybe not so much. Three New York Fed researchers looked at a particularly silly case:

On September 8, 2008, a six-year-old article about the 2002 bankruptcy of United Airlines’ parent company resurfaced on the Internet and was mistakenly believed to be reporting a new bankruptcy filing by the company. This episode caused the company’s stock price to drop by as much as 76 percent in just a few minutes, before NASDAQ halted trading. After the “news” had been identified as false, the stock price rebounded, but still ended the day 11.2 percent below the previous close.

They construct a model price path (driven by three factors: broad market returns, airline sector returns, and crude prices) for UAUA and compare it to the actual path, and find that the stock took seven days to return to its model/unaffected-by-the-rumor level:

[A]fter three trading sessions, United Airlines’ stock was still trading significantly below the counterfactual level implied by our model. Only on the seventh day after the episode did the stock trade at levels consistent with the absence of any residual effects attributable to the false news shock.

They rule out a number of possible innocent explanations and argue that the results are robust to different ways of constructing the model price. So you're left with some sort of psychological-momentum-technical explanation of United's slow recovery, which is bound to look unsatisfying to a believer in efficient markets.

One potential explanation could be that the lower prices for UAUA reflect higher return requirements given excess volatility: investors are particularly averse to the risk of another 76% intraday drop. The Fed researchers don’t like that hypothesis:

[U]nsurprisingly, realized volatility of UA returns is considerably higher than what would be implied by fundamentals on September 8, the day of the false news release. However, on all subsequent days the actual path of UA realized volatility does not exceed the one-standard-error band implied by the model. Indeed, actual realized volatility fell below the two-standard-error band implied by the model on three of the following days. Hence, according to this model, we are not able to find evidence that there is excessive volatility in UA returns after the release of the false news.

Which assumes the conclusion a bit – the hypothetical worry is not driven by post-crash volatility, but by the crash and worry that that down-76%-in-a-day volatility could return.

You can mentally model this as a stock-specific worry: if UAUA went down 76% because of a fake rumor, doesn’t that show that people are really worried about the stock and/or that there’s something for them to be worried about? Isn’t it rational to demand an extra margin of safety from UAUA for at least a few days, until we’re sure that everything’s fine?

But I wonder whether the better model is that it’s a systemic worry: “the robots just wreaked havoc on UAUA for no reason, and I want out of that name until the robots get themselves sorted.” If that’s right, though, it’s only optically about UAUA: it has nothing to do with United and everything to do with how markets work. So it's not a reason for United to trade lower for a few days, it's a reason for broad market valuations to be down in the long term.

How Well Do Financial Markets Separate News from Noise? Evidence from an Internet Blooper [Liberty Street Economics]

The Persistent Effects of a False News Shock [FRBNY]

Related