The role of media in the credit crunch: The case of the banking sector

Using a Vector Autoregression framework, this paper investigates the dynamic relationship between the intensity of negative media speculation and the market performance of financial institutions. Evidence is provided that over the sub-prime crisis period pessimistic coverage Granger-caused the returns on banking indices, while causality in the opposite direction proved weaker. These findings may imply that journalists not only report on the state of economic reality, but also play an active role in creating it. Investors acting upon sentiment implicit in media reports would have been able to improve their investment performance, as measured by Sharpe ratios and Jensen's alphas.

► We link the frequency of pessimistic words used by media with banking returns. ► Results indicate that media contributed to the severity of recent financial crisis. ► Pessimistic coverage Granger-causes returns on banking indices. ► Consequently, news has the capacity to become a self-fulfilling prophecy. ► We design profitable trading strategies based on pessimistic keyword counts.