Estimating Sentiment, Risk Aversion, and Time Preference from Behavioral Pricing Kernel Theory

47 Pages Posted: 18 May 2012 Last revised: 20 Mar 2017

Giovanni Barone-Adesi

Swiss Finance Institute at the University of Lugano; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Loriano Mancini

Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Hersh Shefrin

Santa Clara University - Leavey School of Business

Date Written: March 10, 2017

Abstract

We apply behavioral pricing kernel theory to estimate aggregate preferences, beliefs, and sentiment from option prices and historical returns. In contrast to non-behavioral empirical pricing kernel analysis, our approach to estimating risk aversion and time preference explicitly controls for sentiment. We find that sentiment, risk aversion, and time preference exhibit strong behavioral patterns across the business cycle, with significant implications for the co-movement of risk and return. For the purpose of corroborating our findings, we compare our estimates to a series of independent variables discussed in the literature.

The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2295896

Keywords: Sentiment, Pricing Kernel, Optimism, Overconfidence, Option Data

JEL Classification: G02, G12

Suggested Citation

Barone-Adesi, Giovanni and Mancini, Loriano and Shefrin, Hersh, Estimating Sentiment, Risk Aversion, and Time Preference from Behavioral Pricing Kernel Theory (March 10, 2017). Swiss Finance Institute Research Paper No. 12-21. Available at SSRN: https://ssrn.com/abstract=2060983 or http://dx.doi.org/10.2139/ssrn.2060983

Giovanni Barone-Adesi

Swiss Finance Institute at the University of Lugano ( email )

Via Buffi 13
CH-6904 Lugano
Switzerland
+41 58 666 4671 (Phone)
+41 58 666 46 47 (Fax)

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Loriano Mancini

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny
Bâtiment Extranef
1015 Lausanne, CH-1015
Switzerland

HOME PAGE: http://sfi.epfl.ch/mancini.html

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Hersh Shefrin (Contact Author)

Santa Clara University - Leavey School of Business ( email )

Dept. of Finance
Santa Clara, CA 95053
United States
408-554-6893 (Phone)
408-554-4029 (Fax)

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