Sentiment, Risk Aversion, and Time Preference
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
May 27, 2014
Swiss Finance Institute Research Paper No. 12-21
This paper provides an empirical, behaviorally-based approach to estimating and interpreting pricing kernels. Pricing kernels are decomposed into a sentiment component and a fundamental component, which are estimated from option and stock prices. Our estimates correlate well with independent sentiment measures such as the Baker-Wurgler index, and also with independent empirical estimates of risk aversion and time preference. Our analysis points out two 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.
The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2295896
Number of Pages in PDF File: 47
Keywords: Sentiment, Risk Aversion, Pricing Kernel, Optimism, Overconfidence
JEL Classification: G02, G12working papers series
Date posted: May 18, 2012 ; Last revised: May 28, 2014
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