Template-Type: ReDIF-Paper 1.0
Series: Tinbergen Institute Discussion Papers
Creation-Date: 2016-04-01
Revision-Date: 2018-01-26
Number: 16-022/IV
Author-Name: Luiz Felix
Author-Workplace-Name: VU University Amsterdam, the Netherlands
Author-Name: Roman Kraussl
Author-Workplace-Name: University of Luxembourg, Luxemburg
Author-Name: Philip Stork
Author-Workplace-Name: VU University Amsterdam, the Netherlands
Title: Single Stock Call Options as Lottery Tickets - Overpricing and Investor Sentiment
Abstract: This paper investigates whether the overpricing of out-of-the money single stock calls can be explained by Tversky and Kahneman's (1992) cumulative prospect theory (CPT). We hypothesize that these options are overpriced because investors overweight small probability events and overpay for positively skewed securities, i.e, lottery tickets. We  find that overweighting of small probabilities embedded in the CPT explains the richness of out-of-the money single stock calls better than other utility functions. Nevertheless, overweighting of small probabilities events is less pronounced than suggested by the CPT, is strongly time-varying and most frequent in options of short maturity. Fluctuations in overweighting of small probabilities are largely explained by the sentiment factor.
Classification-JEL: G02, G12
Keywords: Cumulative prospect theory, Market sentimen, Risk-neutral densities, Call options
File-Url: https://papers.tinbergen.nl/16022.pdf
File-Format: application/pdf
File-Size: 745206 bytes
Handle: RePEc:tin:wpaper:20160022