LIMITS OF ARBITRAGE, RISK-NEUTRAL SKEWNESS, AND INVESTOR SENTIMENT

Shih-Ping Feng and Bi-Juan Chang

The International Journal of Business and Finance Research, 2020, vol. 14, issue 2, 61-71

Abstract: This paper uses individual stock options to examine the effect of limits of arbitrage on the relations between risk-neutral skewness and investor sentiment for the underlying stocks. Empirical results show that the riskneutral skewness tends to be more (less) negative under bearish (bullish) investor sentiment, and the significant relations become stronger especially when there are more impediments to arbitrage in stock options. In addition, the empirical results show that increased bearishness among market investors who dominate the use of index options increases the extent to which risk-neutral skewness is affected by fluctuations in investor sentiment for the underlying stocks. Empirical results show that the limits of arbitrage have important implications for the role of investor sentiment in explaining risk-neutral skewness

Keywords: Risk-Neutral Skewness; Investor Sentiment; Limits of Arbitrage (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:ibf:ijbfre:v:14:y:2020:i:2:p:61-71

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