What news can really tell us? Evidence from a news-based sentiment index for financial markets analysis

This study presents a state-of-the-art approach in measuring financial market sentiment, namely, extracting it from news headlines. The sentiment index is constructed by analysing over 124,000 news items for the 2020-2021 period using natural language processing methods. Its informational power is validated by the strong correlation with the VIX index as well as by the occurrence of common periods of higher volatility of both measures. These findings reinforce the treatment of the news-based index as a true sentiment indicator and contribute to its usage independently of any financial instruments. Additionally, a direction of significant correlation coefficients between the sentiment indicator and selected financial assets is consistent with the natural logic of capital flows in financial markets. At the same time, the developed tool allows to identify not only market sentiment, but also the main factors contributing to its direction and time periods in which they are of most significance. It is necessary to understand that the analysed period is specific as it coincides with the outbreak and development of the COVID-19 pandemic. This was reflected in the results that highlight coronavirus as the dominant topic throughout the dataset.