How Much Can Machines Learn Finance from Chinese Text Data?

How much can we learn finance directly from text data? This paper presents a new framework for learning textual data based on the factor augmentation model and sparsity regularization, called the factor-augmented regularized model for prediction (FarmPredict), to let machines learn financial returns directly from news. FarmPredict allows the model itself to extract information directly from articles without predefined information, such as dictionaries or pretrained models as in most studies. Using unsupervised learned factors to augment the predictors would benefit our method with a “double-robust” feature: that the machine would learn to balance between individual words or text factors/topics. It also avoids the information loss of factor regression in dimensionality reduction. We apply our model to the Chinese stock market with a large proportion of retail investors by using Chinese news data to predict financial returns. We show that positive sentiments scored by our FarmPredict approach from news generate on average 83 basic points (bps) stock daily excess returns, and negative news has an adverse impact of 26 bps on the days of news announcements, where both effects can last for a few days. This asymmetric effect aligns well with the short-sale constraints in the Chinese equity market. The result shows that the machine-learned prediction does provide sizeable predictive power with an annualized return of 54% at most with a simple investment strategy. Compared with other statistical and machine learning methods, FarmPredict significantly outperforms them on model prediction and portfolio performance. Our study demonstrates the far-reaching potential of using machines to learn text data. This paper was accepted by Kay Giesecke, finance. Funding: This study was supported by the National Natural Science Foundation of China [Grants 71991471, 71991470, and 72204049], the National Key Research and Development Program [Grant 2020YFA0608604], the Shanghai Pujiang Scholar Project [Grant 21PJC010], the Shanghai Science Project [Grant 23692119300], and the China Postdoctoral Science Project [Grants 2019M650076 and 2020T130107]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.01468 .