Central bank communication in the media and investor sentiment

Abstract

This paper explores the relationship between central bank communication and investor sentiment. We first use media coverage on Fed chair’s communication to quantify the degree of confidence and optimism expressed by the Fed chair and call this variable the overconfidence indicator. Second, we relate the overconfidence indicator to investor sentiment. Our results show that an overconfident Fed chair is significantly associated with higher investor sentiment. Further extensions suggest that (i) investors are more sensitive to central bank communication during a recession and that (ii) they adjust rapidly their sentiment following central bank communication, thus showing that there is no underreaction bias. These findings provide additional insights on how central bank communication shapes investor sentiment in the context of the Global Financial Crisis and the zero lower bound on nominal interest rates.