Mixing Financial Stress with GPT-4 News Sentiment Analysis for Optimal Risk-On/Risk-Off Decisions

Abstract

This paper introduces a new risk-on risk-off strategy for the stock market, which combines a financial stress indicator with a sentiment analysis done by ChatGPT reading and interpreting Bloomberg daily market summaries. Forecasts of market stress derived from volatility and credit spreads are enhanced when combined with the financial news sentiment derived from GPT4. As a result, the strategy shows improved performance, evidenced by higher Sharpe ratio and reduced maximum drawdowns. The improved performance is consistent across the NASDAQ, the S&P 500 and the six major equity markets, indicating that the method generalises across equities markets.

Keywords: Market stress, Volatility, News sentiment, Investment strategy

JEL Classification: G14, D81, C55, G17