Limits of Arbitrage, Sentiment and Pricing Kernel: Evidence from S&P 500 Options
نویسنده
چکیده
This paper uses S&P 500 index options data to examine whether proxies of investor sentiment, or aggregate errors in investor beliefs, affect option prices and asset pricing kernel. I find that when market sentiment becomes more bearish (resp. bullish), both index option smile and asset pricing kernel are more (resp. less) negatively sloped. These relations are statistically and economically significant. They are robust and can not be explained by popular rational representative agent based option pricing models. Further, the impact of investor sentiment is stronger when there are more impediments to arbitrage in the index options. These findings suggest that sentiment matters for asset pricing.
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