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Hedging financial turbulence risk with textual analysis

Author

Listed:
  • Liu, Qingfu
  • Tse, Yiuman
  • Wang, Chuanjie
  • Yang, Jiaer

Abstract

Financial turbulence poses substantial challenges to risk management and investment decision-making, particularly in emerging markets. This study constructs a novel Chinese Financial Turbulence Index (FTI) using a dictionary-based method augmented by generative artificial intelligence, drawing from a corpus of over 3.6 million financial news articles spanning 2012 to 2023. The FTI exhibits strong responsiveness to macroeconomic conditions and market uncertainty, and significantly predicts negative market returns. To mitigate risks associated with financial turbulence, we develop a hedging framework that integrates scaled principal component analysis (sPCA) with a portfolio-mimicking strategy. The resulting hedging portfolio, which is based on firm-level financial resilience characteristics and complemented by non-equity assets, effectively offsets turbulence-related risks. The FTI and the proposed hedging approach offer timely and practical tools for monitoring and managing financial turbulence.

Suggested Citation

  • Liu, Qingfu & Tse, Yiuman & Wang, Chuanjie & Yang, Jiaer, 2026. "Hedging financial turbulence risk with textual analysis," Pacific-Basin Finance Journal, Elsevier, vol. 96(C).
    • Handle: RePEc:eee:pacfin:v:96:y:2026:i:c:s0927538x26000089
    DOI: 10.1016/j.pacfin.2026.103062
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