European Finance Review 7: 235–248, 2003. © 2003 Kluwer Academic Publishers. Printed in the Netherlands. 235 Mood and Judgment of Subjective Probabilities: Evidence from the U.S. Index Option Market DORON KLIGER 1 and ORI LEVY 2 1 University of Haifa, Israel. E-mail: kliger@econ.haifa.ac.il; 2 The University of Haifa, Israel. E-mail: orilevy@econ.haifa.ac.il Abstract. Numerous psychological studies show that weather conditions affect people’s mood and that mood states are correlated with people’s subjective evaluation of future probabilities. In this paper, a new approach is developed and asset market data are employed to test the mood-subjective probability relation. Cloud cover and precipitation volume serve as two mood proxies. Our statistical analysis suggests that bad mood states are characterized by investors placing higher probabilities on adverse events. Key words: mood, state prices, subjective probabilities, weather JEL classification codes: D81. 1. Introduction Numerous psychological studies claim that mood states influence individuals’ sub- jective evaluation of future event probabilities, in a way that bad mood increases the subjective probability of undesired outcomes. 1 The goal of this paper is to test whether mood affects the subjective beliefs of capital market participants. To the best of our knowledge, asset market data were not previously employed to test the conjecture that subjective evaluations of future uncertainties are mood-related. This paper constitutes an attempt to fill this gap. Accumulated evidence suggests that weather conditions, such as humidity levels, number of sunshine hours, and precipitation volume, are correlated with people’s mood. 2 To date, the relation between psychological factors and returns has been empirically supported. 3 We aim at delving into the generating mechanism of 1 For example, Bower (1983), Butler and Mathews (1983), Johnson and Tversky (1983), Schwarz and Clore (1983), Kavanagh and Bower (1985), Butler and Mathews (1987), Mayer et al. (1992), Wright and Bower (1992), Constans and Mathews (1993), and Mayer and Hanson (1995). 2 For example, Cunningham (1979), Sanders and Brizzolara (1982), Howarth and Hoffman (1984), and Eagles (1994). 3 Saunders (1993) and Hirshleifer and Shumway (2001) examine the effect of weather conditions on stock returns; Kamstra et al. (2000) use daylight-savings time changes to document the impact of sleep patterns on stock market returns; Kamstra et al. (2001) examine relations between stock Downloaded from https://academic.oup.com/rof/article/7/2/235/1609509 by guest on 17 December 2023