Originally posted at Fast Company by Ivan Indriawan, Adrian Fernandez-Perez, Alexandre Garel, and Alex Edmans

We like to think our purchase decisions are based on rational calculations and facts, but we know they are often driven by emotions, too. When we splurge on nice food, clothes, or electronic gadgets, are we really thinking in terms of cost and benefit, or are we responding to stress, frustration, happiness, or excitement?

The same can be asked of financial markets. The famous “efficient markets hypothesis” argues that stock prices are driven by rational calculations. But traders are human, and humans are affected by emotions. Do these emotions feed through to the stock market?

Studying this question is difficult because people’s emotions aren’t observable. While emotions do manifest in observable actions, many such actions (aggressive behavior or language, for example) are not captured by any data.

But what if there were a way to measure the overall mood of a country and relate that to the behavior of financial markets? In the age of Spotify, this has become a real possibility.

Our research, published in the Journal of Financial Economics, uses the music people listen to as a measure of national sentiment affecting market behavior. It builds on the concept of a “mood congruence”—that people’s music choices reflect their mood (sad songs at funerals, happy songs at parties and so on).

Spotify provides aggregated listening data across a country, as well as an algorithm that classifies the positivity or negativity of each song. Using these inputs, we calculate “music sentiment”—a measure of a country’s sentiment as expressed by the positivity of the songs its citizens listen to.

HOW IS SENTIMENT USUALLY MEASURED?
Investor sentiment is often defined as the general mood among investors regarding a particular market or asset. While this definition is widely accepted, it’s challenging to construct a pure measure of mood that isn’t complicated by economics.

Many natural measures—consumer confidence, GDP growth, unemployment, coronavirus cases and deaths—have direct economic effects. So, for example, if a high consumer confidence index sees the stock market rise, this doesn’t necessarily suggest emotions directly affect the stock market.

Rather, the rise could be a rational response to an improvement in the business and employment conditions the index is based on. One alternative, then, is to look for other “mood proxies” as viable indicators of national sentiment.

Previous research on investor sentiment has used shocks that affect the national mood but not the economy, such as the results of major sports tournaments.

Read more at Fast Company

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