Measures Of Investor Sentiment: A Comparative Analysis Put-Call Ratio Vs. Volatility Index

Abstract

Traditional research on asset pricing has focused on firm-specific and economy-wide factors that affect asset prices.  Recently, the finance literature has turned to non-economic factors, such as investor sentiment, as possible determinants of asset prices (see for example, Fisher and Statman 2000 and Baker and Wurgler 2006).  Studies such as Baek, Bandopadhyaya and Du (2005) suggest that shifts in investor sentiment may explain short-term movements in asset prices better than any other set of fundamental factors.  A wide array of investor sentiment measures are now available, which leads us quite naturally to the question of which measure best mirrors actual market movements.   In this paper, we begin to address this question by comparing two measures of investor sentiment which are computed daily by the Chicago Board Options Exchange (CBOE) and for which historical data are freely available on the CBOE website, thus making them ideal for use by both academics and practitioners studying market behavior: the Put-Call Ratio (PCR) and the Volatility Index (VIX).  Using daily data from January 2, 2004 until April 11, 2006, we find that the PCR is a better explanatory variable than is the VIX for variations in the S&P 500 index that are not explained by economic factors.  This supports the argument that, if one were to choose between these two measures of market sentiment, the PCR is a better choice than the VIX.