Narrative drives return. We define narrative as the description and representation of unscheduled unique information that usually does not take the form of numbers that can be easily reflected in quantitative analysis. Narrative both creates and resolves uncertainty. Narrative attempts to provide meaning to unscheduled unique information that cannot be easily converted into some measure of risk. Unscheduled unique information is by definition not countable, so it cannot be given a probability measure. It is novel and thus given value through stories or interpretation as an attempt to reduce uncertainty.
Narratives both represents and addresses the Knightian uncertainty found in information that cannot be converted into something countable. Nevertheless, just because information cannot be converted into a measure of risk does not mean that it cannot drive returns. Narratives impact sentiment and creates memes and focuses the attention of investors. A positive narrative may generate popularity which will impact demand and drive prices.
Professor Nicolas Mangee, through the series Studies in New Economic Thinking, begins his new book How Novelty and Narratives Drives the Stock Market with a description that encompasses the problem and the compelling investor interest in this work. His work attempts to provide some structure around the narrative problem.
“Where there is novelty, there is instability. Where there is instability there is uncertainty. Where there is uncertainty there are narratives – narratives are the currency of uncertainty.”
While I am a quant, I accept that narratives and stories associated with unscheduled information may be a key driver of the daily back and forth that drives prices. Unfortunately, we are only at the infancy of being able to extract systematic narrative drivers.
Thoughts on narrative:
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