Investor Sentiment and Option Prices
Dice Center Working Paper No. 2004-2
34 Pages Posted: 19 Mar 2005
There are 2 versions of this paper
Investor Sentiment and Option Prices
Investor Sentiment and Option Prices
Abstract
This paper examines whether investor sentiment about the stock market affects prices of the S&P 500 options. I find that the index option volatility smile is steeper (flatter) and the risk-neutral skewness of monthly index return is more (less) negative when market sentiment becomes more bearish (bullish). These significant relations are robust and become stronger when there are more impediments to arbitrage in index options. They can not be explained by rational perfect-market based option-pricing models. Changes in sentiment help explain time variation in the slope of index option smile and risk-neutral skewness beyond factors suggested by the current models.
Keywords: sentiment, pricing kernel, skewness, limits to arbitrage, index option smile
JEL Classification: G12, G13, G14, G10
Suggested Citation: Suggested Citation
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