Optimal portfolio construction using qualitative and quantitative signals

Finance and accounting research has recently focused on extracting the tone or sentiment of a document (such as an earnings press release, cover story about a company, or management's presentations to analysts) by using positive or negative words/phrases in the document. This chapter shows that signals based on tone or sentiment (extracted from qualitative data) can achieve abnormal returns, and in some studies, incremental abnormal returns beyond quantitative signals. In this chapter, the authors exploit the information content of qualitative data in addition to quantitative signals in selecting optimal portfolios. Using optimization techniques developed by Brandt, Santa-Clara, and Valkanov (2009), and later extended by Hand and Green (2011), the authors show that significantly higher returns can be obtained by combining quantitative and qualitative data obtained from firms' Management Discussion and Analysis (MD&A) sections of their Form 10-Q (10-K) SEC filings than using quantitative signals.