Behavioral in the Short-run and Rational in the Long-run? Evidence from S&P 500 Options

An Empirical Study of the Sentiment Capital Asset Pricing Model

“…This inverted U-shape is contrary to the U-shape estimated in several recent empirical studies of the pricing kernel (Bakshi et al, 2010;Sichert, 2018;Driessen et al, 2019).…”

“…Here we show that the Sentiment CAPM predicts a U-shaped pricing kernel and generates the novel prediction that the pricing kernel should have a more pronounced U shape in high sentiment periods. Consistent with this prediction, Driessen et al (2019) empirically investigate the time variation of the pricing kernel and report, "the U-shape is stronger in good times than in bad times. The stronger U-shaped pricing kernel indicates that investors are more sensitive towards large negative and positive returns in good times" (p. 3).…”

“…The stronger U-shaped pricing kernel indicates that investors are more sensitive towards large negative and positive returns in good times" (p. 3). Driessen et al (2019) show that standard asset pricing models including the habit model of Campbell and Cochrane (1999), the long-run risk model of Bansal and Yaron (2004), and the rare disaster models of Gabaix (2012) and Wachter (2013) each produce a monotonically decreasing pricing kernel when projecting the pricing kernel onto the market return, and thus cannot explain the U shape. Using the behavioral asset pricing framework of Shefrin (2008), Barone-Adesi et al (2017) argue for a pricing kernel that has an inverted U-shape, arising from an overcondent representative agent that underweights the tails of the distribution.…”