Speculation Sentiment - Executive Summary

Abstract

I exploit a novel setting to measure disagreement between unsophisticated speculators and smart money, that is, the leveraged exchanged-traded funds (ETFs) primary market. The leveraged ETFs primary market provides observable arbitrage activity that originates from unobservable speculative demand shocks that create relative mispricing between a leveraged ETF and its underlying derivative securities. I form the Speculation Sentiment Index using the realized arbitrage trades and the index proxies for the direction and magnitude of market-wide speculative demand shocks. The Speculation Sentiment Index predicts aggregate asset returns, anomaly returns, and it is associated with market-wide mispricing and arbitrage activity.