Low probability events are overweighted in the pricing of out-of-the-money index puts and single stock calls. This behavioral bias is strongly time-varying, and is linked to equity market sentiment and higher moments of the risk-neutral density. We _nd that our implied volatility (IV) sentiment...

This paper investigates whether the overpricing of out-of-the money single stock calls can be explained by Tversky and Kahneman's (1992) cumulative prospect theory (CPT). We argue that these options are overpriced because investors' overweight small probability events and overpay for such...