The Effects of Message Board Information Dissemination on Stock Activity By Praveen Ghanta Submitted to the Department of Electrical Engineering and Computer Science in Partial Fulfillment of the Requirements for the Degrees of Bachelor of Science in Electrical [Computer] Science and Engineering and Master of Engineering in Electrical Engineering and Computer Science at the Massachusetts Institute of Technology May 16, 1999 © Copyright 1999 Praveen Ghanta. All rights reserved. The author hereby grants to M.I.T. permission to reproduce and distribute publicly paper and electronic copies of this thesis and to grant others the right to do so. Author Department of Electrical Eggingeging and Computer Science May 17, 1998 Certified by_ eisor Accepted by_ Arthur C. Smith Chairman, Department Committee on Graduate Theses The Effects of Message Board Information Dissemination on Stock Activity by Praveen Ghanta Submitted to the Department of Electrical Engineering and Computer Science May 16, 1999 In Partial Fulfillment of the Requirements for the Degree of Bachelor of Science in Computer Science and Engineering and Master of Engineering in Electrical Engineering and Computer Science ABSTRACT Internet stock message boards provide individual investors with a new information medium that could have several effects on stock activity. Message boards may provide investors with a new information source on small cap stocks. Message boards may affect the trading and volatility of certain stocks by influencing investors. The impact of message board information may vary according to characteristics of the message board. This thesis determines whether message board activity has statistical relationships with stock activity. The research examines how these relationships vary based on message board and stock characteristics. Regression analysis of message board and stock data was performed. The analysis shows that message boards track stock price and trading volume. The quality of the tracking relationship varies according to certain message board characteristics. Message boards have no systematic effects on trading activity, but have increased short term volatility for some small cap stocks. Thesis Supervisor: Michael Siegel Title: Senior Research Scientist, MIT Sloan School of Management 2 Contents 1. Introduction 6 1.1 Thesis O rganization............................................................... 7 1.2 Financial Information on the Internet.......................................... 7 1.3 Introduction to Stock Message Boards.......................................... 8 1.4 Message Boards and Stock Activity............................................ 10 1.4.1 Types of U sers............................................................. 10 1.4.2 Potential Effects........................................................... 10 1.4.3 Aims of Quantitative Analysis.......................................... 11 2. Research Design 12 2.1 D esign V ariables.................................................................. 13 2.1.1 Stocks....................................................................... .. 13 2.1.2 M essage B oards............................................................. 14 2.1.3 Time Frame and Data Availability....................................... 14 2.2 Quantifying Messages............................................................. 15 2.3 Quantitative Analysis............................................................. 16 2.3.1 Price and Price Change Regressions................................... 17 2.3.2 Trading Volume Regressions............................................ 19 2.3.3 Stock Volatility Regressions............................................ 19 2.3.4 Statistical Testing........................................................ 20 3. Stock - Message Board Relationship 21 3 .1 D ata .................................................................................. 2 1 3.2 Stock Price - Message Relationship............................................ 23 3 3.2.1 Predictive or Reactive Relation? ............. .... ...... ....... ..... .. 25 3.2.2 Hourly Regressions...................................................... 27 3.3 Regression Results by Industry................................................. 28 3.3.1 Software/Internet Companies............................................ 28 3.3.2 Biotech/Pharmaceutical Companies................................... 29 3.3.3 Hi-Tech/Hardware Companies.......................................... 30 3.3.4 Large Capitalization Stocks............................................... 32 3.3.5 Comparative Analysis..................................................... 33 3.4 Trading Volume - Message Volume Relationship............................ 35 4. Trading Effects of Message Boards 37 4.1 An Example Scenario............................................................. 37 4.2 O bserved Effects.................................................................. 39 4.2.1 Effects on Information Dissemination.................................. 39 4.2.2 Hyping and Touting on Message Boards.............................. 40 4.2.3 Corporate Reaction...................................................... 42 4.3 Quantitative Analysis............................................................. 43 4.3.1 Volatility Regression Analysis.......................................... 43 4.3.2 Specific Incident Hourly Regressions.................................. 47 5. Characteristics of Effective Message Boards 49 5.1 Defining "Effective" Message Boards.......................................... 50 5.1.1 Message Boards Following Large Cap Stocks....................... 50 5.1.2 Message Boards Following Small Stocks.............................. 50 5.2 Identifying Effective Message Boards.......................................... 51 4 5.3 Characterization of Observed Message Boards................................ 53 5.3.1 Statistical D ata............................................................. 53 5.3.2 Observational Data......................................................... 54 5.3.3 A nalysis.................................................................... 58 6. Conclusions and Future Research 60 6.1 Regression Analysis............................................................... 60 6.2 Message Board Characteristics................................................... 62 6.3 Message Board Design and Business Model................................... 62 6.4 C onclusion ......................................................................... 63 7. Appendices 64 7.1 A ppendix 1......................................................................... 64 7.2 A ppendix 2 ......................................................................... 66 7.3 A ppendix 3......................................................................... 69 7.4 A ppendix 4 ......................................................................... 71 7.5 A ppendix 5......................................................................... 72 8. References 74 5 1 Introduction The recent rise of internet trading and financial sites on the web has given the individual investor considerably more sources of information. Much of the information on the web simply mirrors that available through traditional media sources. More recently, message boards that allow individuals to discuss stocks have gained in popularity. Sites like Yahoo, Silicon Investor, and AOL feature stock message boards. Message board traffic represents a new information source for individual investors, and may influence their investment decisions. With certain stocks, held primarily by individuals, this influence may be reflected in the stocks' performance and volatility. Articles in ZDNet, The Industry Standard, and CNet provide some evidence that message board traffic can have real effects.1 In several instances companies charged individuals with libel and defamation after negative comments purportedly caused a drop in stock price. These and other cases stimulate the need for a systematic analysis of the effects of message board traffic on equities trading. This thesis examines the relationship between message board activity and stock activity. The relationship between message boards and stock activity could potentially have several effects. Message board messages may have a predictive relationship with stock activity in cases where the boards provide new information. Message boards may affect the trading and volatility of certain stocks by influencing investors. This thesis examines stock and message board data in order to determine what these effects are, and how they vary across different message boards. 6 1.1 Thesis Organization Chapter 2 provides a detailed description of the research design used to conduct analyses of the relationships between stocks and message boards. Chapter 3 describes the results of the stock price - message board relationship, and analyzes these results for differences across industries, company size, and other factors. Chapter 4 then discusses the effects of message boards on stock volatility, and examines whether certain cases of stock price spikes were caused by message boards. Chapter 5 analyzes which characteristics determine the effectiveness of message boards as sources of information dissemination. Conclusions and suggestions for further research are made in Chapter 6. 1.2 Financial Information on the Internet With the advent of the Internet, society has been provided a network of information unparalleled in breadth and