A Tale of Two Investors: Estimating Optimism and Overconfidence
Swiss Finance Institute at the University of Lugano; Swiss Finance Institute
Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute
Santa Clara University - Leavey School of Business
July 19, 2013
Swiss Finance Institute Research Paper No. 12-21
We estimate investors' sentiment from option and stock prices by anchoring objective beliefs to a neoclassical pricing kernel. Our estimates of sentiment correlate well with other sentiment measures such as the Baker--Wurgler index, the Yale/Shiller crash confidence index and the Duke/CFO survey responses, and yet contain additional information. Our analysis points out three significant issues related to overconfidence. First, the Baker--Wurgler index strongly reflects excessive optimism but not overconfidence. Second, the dynamics of optimism and overconfidence generate a perceived negative risk-return relationship, while objectively the relationship is positive. Third, overconfidence drives the pricing kernel puzzle.
The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2295896
Number of Pages in PDF File: 50
Keywords: Sentiment, Risk Aversion, Pricing Kernel, Optimism, Overconfidence
JEL Classification: G02, G12working papers series
Date posted: May 18, 2012 ; Last revised: July 22, 2013
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