Abstract
Option market prices have often been regarded as a window on investor sentiment about the future price behavior of the underlying asset. Such prices can be very different from model prices and have long been noted by implied volatility plots revealing “smiles” or “smirks”. In this paper a four-moment risk-neutral specification for S&P 500 call option prices is determined using the unique capabilities of Bayesian-based empirical methods for a time period including the 2008-2009 market crash. Results show that investor sentiment clearly signaled the equity market collapse of 2008-09 as revealed by significant relative call option market underpricing and reinforced by the presence of anomalous volatility skews.
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