Estimating Sentiment, Risk Aversion, and Time Preference from Behavioral Pricing Kernel Theory
Giovanni Barone-Adesi, Loriano Mancini and Hersh Shefrin
We apply behavioral pricing kernel theory to estimate aggregate preferences, beliefs, and sentiment from option prices and historical returns. In contrast to non-behavioral empirical pricing kernel analysis, our approach to estimating risk aversion and time preference explicitly controls for sentiment. We find that sentiment, risk aversion, and time preference exhibit strong behavioral patterns across the business cycle, with significant implications for the co-movement of risk and return. For the purpose of corroborating our findings, we compare our estimates to a series of independent variables discussed in the literature.