Investor sentiment, variance risk premium and delta-hedged gains

Yankun Chen, Jinghong Shu and Jin E. Zhang

Applied Economics, 2016, vol. 48, issue 31, 2952-2964

Abstract: Delta-hedged gains are supposed to be negative and represent a volatility risk premium. Using a sample of Standard & Poor 500 index options from 2006 to 2009, this study documents two anomalies that cannot be explained by the volatility risk premium. First, delta-hedged gains are more negative for out-of-money options than for at-the-money options. Second, delta-hedged gains are significantly positive during financial crisis period. We propose a behavioural explanation in which both option prices and stock prices are affected by investor’s sentiment, but pessimistic sentiment has a greater impact on stock market than option market. This asymmetric response to pessimistic mood in turn affects the relative expensiveness of option prices.

Date: 2016
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DOI: 10.1080/00036846.2015.1133894

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