Investor sentiment, misreaction, and the skewness‐return relationship

This study examines the effect of investor sentiment on misreaction and explores the time-series relationship between risk-neutral skewness (RNS) and subsequent stock market returns contingent on sentiment-induced overreaction. Using the adjusted put-call implied volatility spread as a misreaction proxy and Bakshi et al.'s method to measure RNS, we find that pessimism leads to overreaction. This overreaction could strengthen the negative RNS-return relationship, with higher market returns following lower RNS. Our results are robust even after excluding the sample period of the 2008 financial crisis, profiting from market-timing strategies based on the levels of RNS and overreaction, and using an alternative RNS measure.