Google AdWords is the new Market Risk Premium

Updated: Dec 3, 2019

There has been a long-time battle of the theory and philosophy of Market Risk Premium in the CAPM model. Many argue that Market Risk Premium creates a circular reference when calculating the market expectations that include the underlying stock in its formula. Option trading volume is a better indicator of market direction or specific stock direction. Options are derivative contracts on the underlying stock. The delta in option price directly correlates to the price of the stock the contracts are written.

Finance has evolved with the advancements in technology, and old asset pricing models are now obsolete. After the digitization of stock market trading, companies wasted no time finding arbitrage in ignorance. High-frequency and algorithmic trading are the new normal, and pricing is primarily based on technical trends than fundamentals. Most importantly, in the Information Age, data is driving asset pricing more than technicals or fundamentals. Google and other sources of media are the market movers of today. Artificially intelligent machines that learn as they go are trolling the internet for breaking news that would potentially affect asset pricing or the stock price. These bots are reading every article posted, watching every video or TV show produced, analyzing, and assessing a sentiment index or the market or underlying stock.

Virtually, trading bots are determining the effective "mood" of the stock market and altering their trading strategy on the fly. For example, when Disney reported positive Q3:2019 earnings, the news broke mid trading day, and it took fifteen minutes for the algorithms to respond to the sentiment. Some may think that is a quick response for an entire market to react to breaking news. However, high-frequency traders consider the fifteen minutes an eternity in that high-frequency trading dominates the market and has a very hyper-focused view on time in and out of the market. There seems to be some meat on the bone to close the arbitrage gap between when news breaks and how fast trading bots can respond.

Therefore, a new financial metric to consider is the market pricing of Google Adwords. This hypothesis is not confirmed, although I am highly confident in its validity. If media information determines the direction of a stock price, then we should start at the source of data before it is published. How do you get access to information before it is published? Google has an entire market place that values keywords with a bid/ask price based on the demand of the keyword. For example, the value of the keyword "Tesla" will fluctuate based on how many times the keyword appears in articles, videos, and other publications throughout the internet. The value of the keyword will rise with demand when there is big breaking news regarding the company, good or bad news. Trading bots perform their best and show to make better investment decisions when there is sufficient information to decipher through.

Trading bots analyze three primary factors to determine market sentiment;

  1. Frequency - of published information

  2. Volume - of information in publications

  3. Gravity - of the source of information

The rate of published work about a specific topic will change the delta of the keyword valuation. For example, the more frequent a topic is discussed in media and published, the higher the value of the keyword. Frequency alone would not help us determine the direction of a stock price. Volume refers to the detail provided on the specific topic for the trading bots to read and assess sentiment based on the tone of the publication. The gravity of the source of information helps the trading bots determine between real and fake news, which is particularly crucial in today's environment. A high gravity source of information would be CNBC or Bloomberg, while a low gravity maybe someone with meager followers or a small audience.

To conclude, the financial system is evolving, and the pricing models need to be updated. Data is a driver of financial markets and policies. Media is the catalyst for individual stock price change. Google's keywords are a leading indicator of stock price if correlated to Frequency, Volume, and Gravity of data. There is still arbitrage or "meat on the bone" for the astute investors to gavage.

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