Investor sentiment, misreaction, and the skewness‐return relationship

This study examines the effect of investor sentiment on misreaction and explores the time‐series relationship between risk‐neutral skewness (RNS) and subsequent stock market returns contingent on sentiment‐induced overreaction. Using the adjusted put‐call implied volatility spread as a misreaction p...

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Bibliographic Details
Published inThe journal of futures markets Vol. 41; no. 9; pp. 1427 - 1455
Main Author Chen, Chin‐Ho
Format Journal Article
LanguageEnglish
Published Hoboken Wiley Periodicals Inc 01.09.2021
Subjects
Economic crisis
Investor behavior
investor sentiment
Investors
Market timing
misreaction
Pessimism
risk‐neutral skewness
Securities markets
Skewness
Volatility
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Summary:This study examines the effect of investor sentiment on misreaction and explores the time‐series relationship between risk‐neutral skewness (RNS) and subsequent stock market returns contingent on sentiment‐induced overreaction. Using the adjusted put‐call implied volatility spread as a misreaction proxy and Bakshi et al.'s method to measure RNS, we find that pessimism leads to overreaction. This overreaction could strengthen the negative RNS‐return relationship, with higher market returns following lower RNS. Our results are robust even after excluding the sample period of the 2008 financial crisis, profiting from market‐timing strategies based on the levels of RNS and overreaction, and using an alternative RNS measure.
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ISSN:0270-7314
1096-9934
DOI:10.1002/fut.22215