Who is the more overconfident trader? Individual vs. institutional investors

Guided by the Gervais and Odean (2001) overconfident trading hypothesis, we comprehensively investigate the trading behavior of individual vs. institutional investors in Taiwan in an attempt to identify who is the more overconfident trader. Conditional on the various states of the market, on market volatility, and on the risk level of the securities they trade, we find that both individual and institutional investors trade more aggressively following market gains in bull markets, in up-market states, in up-momentum market states, and in low-volatility market states and that only individual investors trade more in riskier securities following market gains. More importantly, we find that individual investors trade more aggressively following market gains in the three conditional states of the market and in high-volatility market states than institutional investors. Also, individual investors trade more in relatively riskier securities following gains than institutional investors. These findings provide evidence that individual investors are more overconfident traders than institutional investors.     

The Sensitivity of Individual and Institutional Investors' Expectations to Changing Market Conditions: Evidence from Closed-End Funds

This study investigates whether individual and institutional investors respond differently to changes in market conditions. Closed-end funds are the medium used to test the hypothesis because closed-end fund shares (held primarily by individual investors) and the underlying assets (held primarily by institutional investors) are claims to the same stream of distributions. The empirical results suggest that individual investors are more responsive than institutional investors to changes in market conditions. Moreover, although the response of institutional investors differs across stock and bond markets, we cannot reject the hypothesis that the additional sensitivity of individual investors' expectations is uniform across stock and bond markets.     

Who exacerbates the extreme swings in the Chinese stock market?

We investigate which investors buy or sell relatively more on the days when the absolute value of market returns or the daily range of market index prices exceeds 5% in the Chinese stock market. Unlike Dennis and Strickland [Journal of Finance 57(5): 1923–1949 (2002)] who find that institutional investors are buying (selling) more when there is a large market increase (decline) in U.S. equity markets, we find that institutional investors in China are systematically buying more than the less sophisticated individual investors during extreme market swings, particularly on extreme market-down days. We reveal that institutional investors in China (primarily pension funds), provide a stabilizing influence during market downturn days. Our findings highlight the benefits of having active institutional investors in an extremely volatile emerging market dominated by less sophisticated individual investors.     

US, UK and European Stock Market Integration

Abstract:   This paper examines long‐run convergence between US, UK and seven European stock markets. We report evidence to suggest that while real short‐run diversification gains may occur, in general they tend to be short‐lived. However we also find that US and UK markets are relatively less bound to a common trend, which would imply that increased stock market merger activity, and any transition to the European common currency by the UK, may lead to relatively large stock market adjustments as markets adapt to these institutional changes.     

Portfolio diversification effects of trading blocs: The case of NAFTA

This study investigates the evolving nature of North American Free Trade Agreement (NAFTA) stock market interdependencies and their association with diversification gains from the perspective of US investors. The issues are addressed for both short- and long-run interdependencies through correlation of stock market returns and cointegration of stock market prices. The basic findings include: (1) the existence of a long-term relationship (a cointegration relation) which is time-varying and statistically unstable and (2) diversification gains with cointegration not consistently lower than without cointegration. Thus, per-unit-of-risk diversification gains to US investors from NAFTA stock markets are determined by return volatilities, return correlations and domestic market performance. Based on increased return volatilities and return correlations and the very small per-unit-of-risk diversification gains even when the US stock market performs poorly, US investors’ diversification gains have diminished since the implementation of NAFTA.     

Market ambiguity and individual investor information demand

We examine whether ambiguity in the market leads to an increase in information demand by individual investors. Drawing on the asset-pricing model proposed by Mele and Sangiorgi (2015), which incorporates market ambiguity, we measure individual information demand using daily Google searches and measure market ambiguity using a metric based on the market trades of institutional investors. We find that individual investors increase their information demand during periods of greater market ambiguity. We also provide evidence that information demand from individual investors spikes around earnings announcement days primarily when market uncertainty is driven by net-selling activity. Overall, these results suggest that the disagreement among institutional investors either represents uncertainty or contributes to the uncertainty related to a stock, leading to increased demand for information from individual investors.     

‘Slow-burn’ spillover and ‘fast and furious’ contagion: a study of international stock markets

‘Fast and furious’ contagion across capital markets is an important phenomenon in an increasingly integrated financial world. Different from ‘slow-burn’ spillover or interdependence among these markets, ‘fast and furious’ contagion can occur instantly. To investigate this kind of contagion from the US, Japan and Hong Kong to other Asian economies, we design a research strategy to capture fundamental interdependence, or ‘slow-burn’ spillover, among these stock markets as well as short-term departures from this interdependence. Based on these departures, we propose a new contagion measure which reveals how one market responds over time to a shock in another market. We also propose international portfolio analysis for contagion via variance decomposition from the portfolio manager’s perspective. Using this research strategy, we find that the US stock market was cointegrated with the Asian stock markets during four specific periods from 3 July 1997 to 30 April 2014. Beyond this fundamental interdependence, the shocks from both Japan and Hong Kong have significant ‘fast and furious’ contagion effects on other Asian stock markets during the US subprime crisis, but the shocks from the US have no such effects.     

Realized volatility spillovers between US spot and futures during ECB news: Evidence from the European sovereign debt crisis

We study the simultaneity impact of the European Central Bank news on the daily realized volatility transmission mechanism (spillovers) among various US spot and futures markets. To this end, we apply a bias-corrected vector autoregressive model via Wild bootstrap simulation. We use minute-by-minute intraday data to construct daily realized volatility. We consider 429 news form the ECB as important events employing two major classifications, namely, a country classification with the highest total number of days related ECB news and a type of ECB news classification. We find that investors in futures markets react more vigorously and mainly for the ECB news that is associated with the group of EMU member states applied structural reforms. Yet, more importantly, we show that the US stock markets response heterogeneously to the ECB news, as we find key disagreements in the reactions both across the US markets and the types of ECB news studied. Such evidence is consistent with the explanation of the differential interpretation of information among market participants. From a practical point of view, we suggest that investors in the US spot market can effectively use two or more futures contracts to minimize their exposure to volatility risk associated with that news.     

Enhancing the efficiency of securities markets in East Asia

We explore the relative efficiency of stock markets across countries using newly available data on transactions costs and the quality of the informational environment of stock markets. These new measures are constructed from firm-level stock returns in a panel of 60 countries for the period 2000–2004. We develop a framework to understand the linkages between efficiency, liquidity, transactions costs, and informational quality and then study their determinants. We find that some institutional arrangements – such as the availability of stock lending and short selling – and the openness of markets are associated with lower transactions costs. We also find that, although disclosure rules for directors and officers of listed firms are essential, the ability of shareholders to seek redress is more conducive to a better informational environment in stock markets. This in turn serves as the basis for policy recommendations for the East Asian region. In particular, the region needs to continue to strengthen the implementation and enforcement of corporate governance, to further enhance the market and institutional infrastructure, and focus on measures to foster a larger and more diversified investor base, in order to continue to see gains in the efficiency of stock markets.     

Risk spillovers from China's and the US stock markets during high-volatility periods: Evidence from East Asianstock markets

This paper studies cross-country risk spillovers through C-vine copula quantile regression. We find Both China's and the US markets can result in large risk spillovers to East Asian markets. Furthermore, their significant conditional spillovers indicate they can emit risk through an intermediary market. However, their distinctive dependency structures with East Asian markets reflect their differences in spillovers to the markets in magnitude. The risk spillovers from US are stronger than China in magnitude. Moreover, the risk spillover from China's stock market during its high-volatility period is weaker than the whole period, which is contrary to the US market. It may imply Chinese financial influences gradually increase with Chinese financial liberalization and regional integration. Our results have implications for macroprudential regulators adopt the effective supervision and regulation to deal with the cross-border risk spillovers, and for international investors in risk hedging, derivative valuation and investment.     

Volatility dependences of stock markets with structural breaks

We develop a Vector Heterogeneous Autoregression model with Continuous Volatility and Jumps (VHARCJ) where residuals follow a flexible dynamic heterogeneous covariance structure. We employ the Bayesian data augmentation approach to match the realised volatility series based on high-frequency data from six stock markets. The structural breaks in the covariance are captured by an exogenous stochastic component that follows a three-state Markov regime-switching process. We find that the stock markets have higher volatility dependence during turmoil periods and that breakdowns in volatility dependence can be attributed to the increase in market volatilities. We also find positive correlations between the Asian stock markets, the European stock market, and the UK stock market. The US stock market has positive correlations with all other markets for most of the sample periods, indicating the leading position of US stock market in the global stock markets. In addition, the proposed three-state VHARCJ model with Dynamic Conditional Correlation (DCC) and break structure under student-t distribution has a superior density forecast performance as compared to the competing models. The forecast models with structural breaks outperform those without structural breaks based on the log predicted likelihood, the log Bayesian factor, and the root mean square loss function.     

The pricing of foreign exchange risk around the Asian financial crisis: evidence from Taiwan's stock market

The volatile exchange rate movement during the Asian financial crisis has led global investors to re-evaluate the importance of currency exposures in Asian stock markets. In this paper, we examine industry-level currency risk of Taiwan's stock market around the Asian financial crisis. The results show that most export-oriented industries, except for the electronics industry, are positively affected by the depreciation of the New Taiwan Dollars (NTD) against the US Dollars (USD). We also find that the magnitude of currency risk is less for banking and electronics industries in the Taiwan Stock Exchange (TSE) than for those in the over-the-counter (OTC) security exchange. Our results are consistent with the findings of Chow et al. (J. Financial Res. 2 (1997b) 191) and have important implications for international investors with exposures in Taiwan's stock market.     

The dynamics of individual and institutional trading on the Shanghai Stock Exchange

We investigate the daily dynamic relation between returns and institutional and individual trades in the emerging Chinese stock market. Consistent with the hypotheses of trend-chasing and attention-grabbing trading, we find that the response of individual trading to return shocks is much stronger than that of institutional trading, and individuals are net buyers following return shocks. Second, we find that past individual buys and sells have predictive power, whereas past institutional buys and sells have predictive power for market returns in longer horizons. However, both institutional and individual trading activities are more strongly related to past trades than past returns, and individual trading is also influenced by institutional trading. Moreover, we find that institutional trading in the largest quintile leads the trading in the smallest quintile, but no such lead–lag relation is found for individual trades. Finally, we find that the average cumulative abnormal trading volume of individuals is much larger than that of institutions around the firms' earnings announcement, suggesting that less-informed individual investors are more heavily influenced by firm-specific information disclosures and attention-grabbing events.     

Shareholder composition,share turnover,and returns in volatile markets: The case of international REITs

The shareholder composition of listed property companies has changed from the fragmented, retail ownership, to more concentrated, institutional ownership over the past decade. In this paper, we first document significant variation in the composition of the shareholder base across the world's five largest listed property markets. We then examine the relation between the composition of the shareholder base and stock market performance and share turnover during the turbulent trading days of 2008 and 2009. By directly relating the shareholder base of firms to excess returns and turnover on these volatile days, we are able to isolate the importance of shareholder composition during periods when trading behavior is most likely to vary across different types of shareholders. We find that both large block holdings and high levels of institutional ownership decrease trading volumes and moderate stock returns; however, the effects largely occur when stock prices move sharply downward. Moreover, these effects are strongest when ownership concentration and institutional ownership exceed 25 percent. We also find that the disaggregation of institutional investors into distinct categories (banks, pension funds, advisors, etc.) increases our understanding of stock trading and share price dynamics of listed property companies.     

Herding and Feedback Trading by Institutional and Individual Investors

We document strong positive correlation between changes in institutional ownership and returns measured over the same period. The result suggests that either institutional investors positive-feedback trade more than individual investors or institutional herding impacts prices more than herding by individual investors. We find evidence that both factors play a role in explaining the relation. We find no evidence, however, of return mean-reversion in the year following large changes in institutional ownership—stocks institutional investors purchase subsequently outperform those they sell. Moreover, institutional herding is positively correlated with lag returns and appears to be related to stock return momentum.     

An empirical analysis of herd behavior in global stock markets

This paper examines herding behavior in global markets. By applying daily data for 18 countries from May 25, 1988, through April 24, 2009, we find evidence of herding in advanced stock markets (except the US) and in Asian markets. No evidence of herding is found in Latin American markets. Evidence suggests that stock return dispersions in the US play a significant role in explaining the non-US market’s herding activity. With the exceptions of the US and Latin American markets, herding is present in both up and down markets, although herding asymmetry is more profound in Asian markets during rising markets. Evidence suggests that crisis triggers herding activity in the crisis country of origin and then produces a contagion effect, which spreads the crisis to neighboring countries. During crisis periods, we find supportive evidence for herding formation in the US and Latin American markets.     

An empirical evaluation of the overconfidence hypothesis

Recently, several behavioral finance models based on the overconfidence hypothesis have been proposed to explain anomalous findings, including a short-term continuation (momentum) and a long-term reversal in stock returns. We characterize the overconfidence hypothesis by the following four testable implications: First, if investors are overconfident, they overreact to private information and underreact to public information. Second, market gains make overconfident investors trade more aggressively in subsequent periods. Third, excessive trading of overconfident investors in securities markets contributes to the observed excessive volatility. Fourth, overconfident investors underestimate risk and trade more in riskier securities. To document the presence of overconfidence in financial markets, we empirically evaluate these four hypotheses using aggregate data. Overall, we find empirical evidence in support of the four hypotheses.     

Institutional herding in international markets

This paper studies herding behavior of institutional investors in international markets. First, we document the existence of wide-spread herding in 41 countries (referred to as “target countries” hereafter) in the sample. We then examine the relation between contemporaneous institutional demand and future returns and find that institutional herding stabilizes prices. Next, we examine the relation between institutional investors’ herding behavior and the level of information asymmetry in the target countries. We measure the degree of information asymmetry in each target country along five dimensions: (1) stock market development, (2) ease of access to information, (3) corporate transparency, (4) investor rights, and (5) macroeconomic factors that relate to the information environment. We find evidence that institutional investors herd more in markets characterized by low levels of information asymmetry (high level of information transparency). This result suggests that institutional investors’ herding behavior is likely driven by correlated signals from fundamental information. Lastly, we show that price adjustment is faster in informationally transparent markets.     

On measuring synchronization of bulls and bears: The case of East Asia

This paper implements estimation and testing procedures for comovements of stock market “cycles” or “phases” in Asia. We extend the Harding and Pagan [Harding, D., Pagan, A.P., 2006. Synchronization of cycles. Journal of Econometrics 132 (1), 59–79] test for strong multivariate nonsynchronization (SMNS) between business cycles to a test that allows for an imperfect degree of multivariate synchronization between stock market cycles. Moreover, we propose a test for endogenously determining structural change in the bivariate and multivariate synchronization indices. Upon applying the technique to five Asian stock markets we find a significant increase in the cross country comovements of Asian bullish and bearish periods in 1997. A power study of the stability test suggests that the detected increase in comovement is more of a sudden nature (i.e. contagion or “Asian Flu”) instead of gradual (i.e. financial integration). It is furthermore argued that stock market cycles and their propensity toward (increased) synchronization contain useful information for both investors, policy makers and financial regulators.     

News release and the role of different types of investors

We examine how investors react to positive and negative news in the Chinese stock market. We show that positive news is followed by a reversal in stock price, while negative news reports are accompanied by a drift. Using a unique account-level dataset, we find that institutional investors' attention bias contributes to the market's absorption process for different types of news, which is different from the conclusion that the phenomenon is driven by retail investors in the U.S. market. We explain the differences between the two markets as the short-sale constraints induce the attention bias of institutional investors in China. Individual investors are not able to correctly judge the content of news reports, and act as a liquidity provider. We highlight the market regulation plays an important role in the process of investors analyzing information.