Investor Sentiment and Price Discovery: Evidence from the Pricing Dynamics between the Futures and Spot Markets
45 Pages Posted: 5 Feb 2015
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: Suggested Citation