Single Stock Call Options as Lottery Tickets: Overpricing and Investor Sentiment

Forthcoming in Journal of Behavioral Finance

38 Pages Posted: 7 Apr 2016 Last revised: 5 Aug 2018

See all articles by Luiz F. F. Felix

Luiz F. F. Felix

APG Asset Management

Roman Kräussl

Luxembourg School of Finance; Hoover Institution, Stanford University

Philip A. Stork

Vrije Universiteit Amsterdam, School of Business and Economics; Tinbergen Institute

Date Written: July 31, 2018

Abstract

This paper investigates whether the overpricing of out-of-the money single stock calls can be explained by Tversky and Kahneman's (1992) cumulative prospect theory (CPT). We hypothesize that these options are expensive because investors overweight small probability events and overpay for positively skewed securities, i.e, lottery tickets. We find that overweighting of small probabilities embedded in the CPT explains the richness of out-of-the money single stock calls better than other utility functions. Nevertheless, overweighting of small probabilities events is less pronounced than suggested by the CPT, is strongly time-varying and most frequent in options of short maturity. We find that fluctuations in overweighting of small probabilities are largely explained by the sentiment factor.

Keywords: Cumulative prospect theory; investor sentiment; risk-neutral densities; call options

JEL Classification: G02, G12

Suggested Citation

Felix, Luiz F. F. and Kraeussl, Roman and Stork, Philip A., Single Stock Call Options as Lottery Tickets: Overpricing and Investor Sentiment (July 31, 2018). Forthcoming in Journal of Behavioral Finance, Available at SSRN: https://ssrn.com/abstract=2758641 or http://dx.doi.org/10.2139/ssrn.2758641

Luiz F. F. Felix (Contact Author)

APG Asset Management ( email )

Gustav Mahlerplein 3
Amsterdam, 1082 MS
Netherlands

Roman Kraeussl

Luxembourg School of Finance ( email )

4, rue Albert Borschette
Luxembourg, 1246
Luxembourg
+3524666445442 (Phone)

HOME PAGE: http://www.art-finance.com

Hoover Institution, Stanford University ( email )

Stanford, CA 94305
United States

Philip A. Stork

Vrije Universiteit Amsterdam, School of Business and Economics ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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