Hostname: page-component-586b7cd67f-rdxmf Total loading time: 0 Render date: 2024-12-03T19:54:50.389Z Has data issue: false hasContentIssue false
  • English
  • Français

Sophistication, Sentiment, and Misreaction

Published online by Cambridge University Press:  27 October 2015

Chuang-Chang Chang ,
Pei-Fang Hsieh  and
Yaw-Huei Wang
Chuang-Chang Chang
Affiliation:
[email protected], National Central University, Department of Finance, Taiwan
Pei-Fang Hsieh*
Affiliation:
[email protected], Department of Quantitative Finance, National Tsing Hua University, Taiwan
Yaw-Huei Wang
Affiliation:
[email protected], Department of Finance, National Taiwan University, Taipei, Taiwan.
*
*Corresponding author: [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

This study investigates whether the existence or strength of any misreaction in the options market is affected by investor sophistication and investor sentiment. Based on a unique data set of the complete history of all transactions in the Taiwan options market, we find that individual investors exhibit significant misreaction to information and that this misreaction becomes stronger during periods of high investor sentiment. In addition, more active or aggressive individual investors always exhibit misreaction and do not learn from their past mistakes. Our empirical results are robust to alternative measures of investor sentiment and definitions of long- and short-term horizons.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 50 , Issue 4 , August 2015 , pp. 903 - 928
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2015 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Baker, M., and Wurgler, J.. “Investor Sentiment and the Cross-Section of Stock Returns.” Journal of Finance, 61 (2006), 1645–1680.Google Scholar
Baker, M., and Wurgler, J.. “Investor Sentiment and the Stock Market.” Journal of Economic Perspectives, 21 (2007), 129–151.Google Scholar
Barber, B. M.; Lee, Y.-T.; Liu, Y.-J.; and Odean, T.. “Just How Much Do Individual Investors Lose by Trading?” Review of Financial Studies, 22 (2009), 609–632.Google Scholar
Barber, B. M.; Lee, Y.-T.; Liu, Y.-J.; and Odean, T.. “The Cross-Section of Speculator Skill: Evidence from Day Trading.” Journal of Financial Markets, 18 (2014), 1–24.Google Scholar
Barber, B. M., and Odean, T.. “The Courage of Misguided Convictions: The Trading Behavior of Individual Investors.” Financial Analysts Journal, 55 (1999), 41–55.Google Scholar
Barber, B. M., and Odean, T.. “Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors.” Journal of Finance, 55 (2000), 773–806.CrossRefGoogle Scholar
Barber, B. M., and Odean, T.. “Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment.” Quarterly Journal of Economics, 116 (2001), 261–292.CrossRefGoogle Scholar
Barber, B. M., and Odean, T.. “All That Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors.” Review of Financial Studies, 21 (2008), 785–818.Google Scholar
Black, F., and Scholes, M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637–659.CrossRefGoogle Scholar
Bollen, N., and Whaley, R.. “Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?” Journal of Finance, 59 (2004), 711–753.Google Scholar
Britten-Jones, M., and Neuberger, A.. “Option Prices, Implied Price Processes and Stochastic Volatility.” Journal of Finance, 55 (2000), 839–866.Google Scholar
Brown, G. W., and Cliff, M. T.. “Investor Sentiment and the Near-Term Stock Market.” Journal of Empirical Finance, 11 (2004), 1–27.CrossRefGoogle Scholar
Brown, G. W., and Cliff, M. T.. “Investor Sentiment and Asset Valuation.” Journal of Business, 78 (2005), 405–440.CrossRefGoogle Scholar
Chabi-Yo, F.; Garcia, R.; and Renault, E.. “State Dependence Can Explain the Risk Aversion Puzzle.” Review of Financial Studies, 21 (2008), 973–1011.Google Scholar
Chang, C.-C.; Hsieh, P.-F.; and Lai, H.-N.. “Do Informed Option Investors Predict Stock Returns? Evidence from the Taiwan Stock Exchange.” Journal of Banking and Finance, 33 (2009), 757–764.CrossRefGoogle Scholar
Chang, C.-C.; Hsieh, P.-F.; Tang, C.-W.; and Wang, Y.-H.. “The Intraday Behavior of Information Misreaction Across Various Categories of Investors in the Taiwan Options Market.” Journal of Financial Markets, 16 (2013), 362–385.Google Scholar
Chao, C.; Li, H.; and Yu, F.. “Is Investor Misreaction Economically Significant? Evidence from Short- and Long-Term S&P 500 Index Options.” Journal of Futures Markets, 25 (2005), 717–752.Google Scholar
Chung, S.-L.; Hung, C.-H.; and Yeh, C.-Y.. “When Does Investor Sentiment Predict Stock Returns?” Journal of Empirical Finance, 19 (2012), 217–240.Google Scholar
Coval, J. D., and Shumway, T.. “Do Behavior Biases Affect Prices?” Journal of Finance, 60 (2005), 1–34.Google Scholar
Daniel, K.; Hershleifer, D.; and Subrahmanyam, A.. “Investor Psychology and Security Market Under- and Overreactions.” Journal of Finance, 52 (1998), 1839–1885.Google Scholar
Daniel, K., and Titman, S.. “Evidence on the Characteristics of Cross Sectional Variations in Stock Returns.” Journal of Finance, 52 (1997), 1–33.Google Scholar
De Bondt, W. F. M., and Thaler, R. H.. “Does the Stock Market Overreact?” Journal of Finance, 40 (1985), 793–808.Google Scholar
De Long, J. B.; Shleifer, A.; Summers, L. H.; and Waldmann, R. J.. “Positive Feedback Investment Strategies and Destabilizing Rational Speculation.” Journal of Finance, 45 (1990), 379–396.Google Scholar
Figlewski, S. “Option Arbitrage in Imperfect Markets.” Journal of Finance, 44 (1989), 1289–1311.Google Scholar
Gervais, S., and Odean, T.. “Learning To Be Overconfident.” Review of Financial Studies, 14 (2001), 1–27.Google Scholar
Green, T. C., and Figlewski, S.. “Market Risk and Model Risk for a Financial Institution Writing Options.” Journal of Finance, 54 (1999), 1465–1499.Google Scholar
Han, B. “Investor Sentiment and Option Prices.” Review of Financial Studies, 21 (2008), 387–414.CrossRefGoogle Scholar
Harrison, J. M., and Kreps, D. M.. “Martingales and Arbitrage in Multiperiod Securities Markets.” Journal of Economic Theory, 20 (1979), 381–408.Google Scholar
Harrison, J. M., and Pliska, S. R.. “Martingales and Stochastic Integrals in the Theory of Continuous Trading.” Stochastic Processes and Their Applications, 11 (1981), 215–260.Google Scholar
Hens, T., and Reichlin, C.. “Three Solutions to the Pricing Kernel Puzzle.” Review of Finance, 17 (2013), 1065–1098.Google Scholar
Hong, H., and Stein, J. C.. “A Unified Theory of Under-Reaction, Momentum Trading and Overreaction in Asset Markets.” Journal of Finance, 54 (1999), 2143–2184.Google Scholar
Jiang, G. J., and Tian, Y. S.. “The Model-Free Implied Volatility and Its Information Content.” Review of Financial Studies, 18 (2005), 1305–1342.Google Scholar
Jiang, G. J., and Tian, Y. S.. “Extracting Model-Free Volatility from Option Prices: An Examination of the VIX Index.” Journal of Derivatives, 14 (2007), 35–60.Google Scholar
Jiang, G. J., and Tian, Y. S.. “Misreaction or Misspecification? A Re-Examination of Volatility Anomalies.” Journal of Banking and Finance, 34 (2010), 2358–2369.Google Scholar
Jordan, D. J., and Diltz, J. D.. “The Profitability of Day Traders.” Financial Analysts Journal, 59 (2003), 85–95.Google Scholar
Kumar, A., and Lee, C. M. C.. “Retail Investor Sentiment and Return Comovements.” Journal of Finance, 61 (2006), 2451–2486.Google Scholar
Kuo, W.-Y., and Lin, T.-C.. “Overconfident Individual Day Traders: Evidence from the Taiwan Futures Market.” Journal of Banking and Finance, 37 (2013), 3548–3561.CrossRefGoogle Scholar
Kurov, A. “Investor Sentiment and the Stock Market’s Reaction to Monetary Policy.” Journal of Banking and Finance, 34 (2010), 139–149.CrossRefGoogle Scholar
Lakonishok, J.; Lee, I.; Pearson, N. D.; and Poteshman, A. M.. “Option Market Activity.” Review of Financial Studies, 20 (2007), 813–857.Google Scholar
Lakonishok, J.; Shleifer, A.; and Vishny, R.. “Contrarian Investment, Extrapolation, and Risk.” Journal of Finance, 49 (1994), 1541–1578.Google Scholar
Lee, C.; Shleifer, A.; and Thaler, R.. “Investment Sentiment and the Closed-End Fund Puzzle.” Journal of Finance, 46 (1991), 75–109.Google Scholar
Lemmon, M., and Ni, S. X.. “The Effects of Investor Sentiment on Speculative Trading and Prices of Stock and Index Options.” Working Paper, University of Utah (2010).Google Scholar
Lemmon, M., and Portniaguina, E.. “Consumer Confidence and Asset Prices: Some Empirical Evidence.” Review of Financial Studies, 19 (2006), 1499–1529.Google Scholar
Mahani, R. S., and Poteshman, A. M.. “Overreaction to Stock Market News and Misevaluation of Stock Prices by Unsophisticated Investors: Evidence from the Option Market.” Journal of Empirical Finance, 15 (2008), 635–655.Google Scholar
Newey, W., and West, K.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.Google Scholar
Odean, T. “Are Investors Reluctant to Realize Their Losses?” Journal of Finance, 53 (1998), 1775–1798.Google Scholar
Odean, T. “Do Investors Trade Too Much?” American Economic Review, 89 (1999), 1279–1298.Google Scholar
Ofek, E.; Richardson, M.; and Whitelaw, R.. “Limited Arbitrage and Short Sales Restrictions: Evidence from the Options Markets.” Journal of Financial Economics, 74 (2004), 305–342.Google Scholar
Pan, J., and Poteshman, A. M.. “The Information in Option Volume for Future Stock Prices.” Review of Financial Studies, 19 (2006), 871–908.Google Scholar
Polkovnichenko, V., and Zhao, F.. “Probability Weighting Functions Implied by Options Prices.” Journal of Financial Economics, 107 (2013), 580–609.Google Scholar
Poteshman, A. M. “Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market.” Journal of Finance, 56 (2001), 851–876.Google Scholar
Shefrin, H. A Behavioral Approach to Asset Pricing. Amsterdam, The Netherlands: Elsevier (2005).Google Scholar
Shleifer, A. Inefficient Markets: An Introduction to Behavioral Finance. Oxford, UK: Oxford University Press (2000).Google Scholar
Shleifer, A., and Vishny, R. W.. “The Limits of Arbitrage.” Journal of Finance, 62 (1997), 35–55.CrossRefGoogle Scholar
Stambaugh, R. F.; Yu, J.; and Yuan, Y.. “The Short of It: Investor Sentiment and Anomalies.” Journal of Financial Economics, 104 (2012), 288–302.Google Scholar
Stein, J. “Overreactions in the Options Market.” Journal of Finance, 44 (1989), 1011–1023.Google Scholar
Tetlock, P. C. “Giving Content to Investor Sentiment: The Role of Media in the Stock Market.” Journal of Finance, 62 (2007), 1139–1168.Google Scholar
Yu, J., and Yuan, Y.. “Investor Sentiment and the Mean–Variance Relation.” Journal of Financial Economics, 100 (2011), 367–381.Google Scholar
Ziegler, A. “Why Does Implied Risk Aversion Smile?” Review of Financial Studies, 20 (2007), 859–904.Google Scholar