The Impact of Blog Recommendations on Security Prices and Trading Volumes

Abstract

Previous research and recent statements by the Securities and Exchange Commission indicate that e-mail spam and message board posts are often used to manipulate markets in a variation of the classical pump-and-dump scheme, leading to temporary market reactions followed by price reversals. In contrast, I hypothesize that financial blogs spread genuine information leading to permanent market adjustments.

I investigate stock recommendations on blogs and find that bloggers tend to write about liquid securities issued by large firms; I also find that bloggers offer short advice consistent with momentum strategies but long advice consistent with contrarian strategies.

To test the hypothesis that stock recommendations on blogs impact both prices and trading volumes of the touted securities, I collect recommendations from blogs and analyze returns and trading volumes on the days surrounding publication; I offer evidence to support my hypothesis and I find some evidence of market reaction being stronger for short recommendations. I hypothesize and test that the magnitude of the market reaction depends on the market capitalization of the touted firm, on the size of the blog's audience, on the depth of the analysis of the blog post and on the perceived skill of the blog's author. I find that the market appears to react more strongly to recommendations given by holders of a graduate degree in Finance or Economics; the other hypothesized factors do not have an impact on the magnitude of the reaction. Finally, I document the absence of price reversals in the twenty days following blog publication, giving support to the hypothesis that blogs offer genuine information.

Keywords: analyst recommendation, market reaction, blogs, event study

JEL Classification: G14