A Novel Market Sentiment Analysis Model for Forecasting Stock and Cryptocurrency Returns

This article develops a method for extracting information related to the underlying stock and cryptocurrency market sentiment from European put and call option prices. We study the evolution of market sentiment and predictability of prices in the S&P 500 index and Bitcoin (BTC/USD) futures markets during the 2020–2022 period. Several innovative temporal entropic and nonentropic measures of market sentiment based on a pessimistic, a market consensus, and an optimistic view are proposed in our nonlinear forecasting models. We show that these measures have significant predictive power for future spot prices at longer forecast horizons, where they statistically and economically outperform alternative models. We also find that the BTC/USD market is more susceptible to extreme sentiments reflected in demand-based shocks, while the information regarding the degree of pessimism in relation to the market consensus is more useful in forecasting the spot S&P 500 index movements in the presence of systemic shocks.