Investor Sentiment and Price Discovery: Evidence from the Pricing Dynamics between the Futures and Spot Markets

45 Pages Posted: 5 Feb 2015

See all articles by Robin K. Chou

Robin K. Chou

National Chengchi University (NCCU)

Chu-Bin Lin

National Chengchi University

George H. K. Wang

George Mason University - Department of Finance

Date Written: December 3, 2014

Abstract

This study shows that investor sentiment has a positive impact on price volatility and bid-ask spread on both the spot and futures markets, which induces higher arbitrage risk and trading costs. We examine the pricing dynamics between the spot and futures markets during high and low sentiment periods. During high sentiment periods, informed traders are less willing to leverage their information advantages on the futures market to avoid exposing themselves to high noise trader risk, which diminishes the futures markets’ leading informational role and contributions to price discovery. These findings provide support for the theory of limits to arbitrage.

Keywords: Information shares, Investor sentiment, Lead-lag relation, Limits to arbitrage

JEL Classification: G02, G12, G14

Suggested Citation

Chou, Robin K. and Lin, Chu-Bin and Wang, George H. K., Investor Sentiment and Price Discovery: Evidence from the Pricing Dynamics between the Futures and Spot Markets (December 3, 2014). Available at SSRN: https://ssrn.com/abstract=2560117

Robin K. Chou (Contact Author)

National Chengchi University (NCCU) ( email )

No. 64, Chih-Nan Road
Section 2
Wenshan, Taipei, 11623
Taiwan

Chu-Bin Lin

National Chengchi University ( email )

No. 64, Chih-Nan Road
Section 2
Wenshan, Taipei, 11623
Taiwan

George H. K. Wang

George Mason University - Department of Finance ( email )

Fairfax, VA 22030
United States

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