Author(s)

Yiwen Zhou, Xuanchen Zhang

Corresponding Author

Yiwen Zhou

Abstract

This paper empirically investigates how we can capture sentiments and subjective expectations of investors from Chinese option markets. Through principal component analysis of six representative sentiment factors including closed-end fund discount, share turnover, number of IPOs, average first day return of IPO companies, amount of new investors, and consumer confidence level, we find they are strongly correlated with and have statistically significant predictability of options implied volatilities. The estimations are robust when adding macroeconomic factors as control variables. Our findings have two main contributions. Firstly, we successfully prove the rich investor sentiment information contained from option implied volatility, which can be considered as a market timing device. Secondly, we exploit advanced machine learning methodologies for variable dimensionality reduction and obtain superior results.

Keywords

Implied volatility, Investor sentiment, Option pricing, Time-series analysis