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Investor Sentiment and Option Prices

Bing Han

University of Toronto, Rotman School of Management

Dice Center Working Paper No. 2004-2
AFA 2006 Boston Meetings

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.

Number of Pages in PDF File: 34

Keywords: sentiment, pricing kernel, skewness, limits to arbitrage, index option smile

JEL Classification: G12, G13, G14, G10

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Date posted: March 19, 2005  

Suggested Citation

Han, Bing, Investor Sentiment and Option Prices. Dice Center Working Paper No. 2004-2; AFA 2006 Boston Meetings. Available at SSRN: https://ssrn.com/abstract=687537 or http://dx.doi.org/10.2139/ssrn.687537

Contact Information

Bing Han (Contact Author)
University of Toronto, Rotman School of Management ( email )
Toronto, Ontario M5S 3E6
4169460732 (Phone)

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References:  58
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