Speculation Spillovers
Yu-Jane Liu, Zheng Zhang, Longkai Zhao
Guanghua School of Management
Peking University
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Outline
1. Motivation
2. Results
3. Empirical Investigation
4. Conclusion
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Motivation
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The impact of derivatives
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Stabilization
Derivatives
Destabilization
• Low cost
• Danthine (1978)
• Stein (1987)
• High margin
• Turnovsky (1983)
• Kraus and Smith (1996)
• High liquidity
• Etc…
• Etc…
Derivatives traders are rational and sophisticated
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WuLiang Put warrant
Source: Xiong and Yu (2010)
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WuLiang Put warrant
Source: Xiong and Yu (2010)
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Behavioral bias exits in derivatives markets
Xiong and Yu (2010)
• 16 deep-out-of-the-money put warrants
• The frenzied trading and spectacular bubble in the Chinese warrants
market
• Greater fool theory (resale option theory)
Other studies
Heath et al. (1999), Poteshman (2001), Horst and Veld (2008), Haigh and
List (2005), Liu, Wang, and Zhao (2010)
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Results
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Speculation spillovers
Research question
What are the impacts of behavioral biases in derivatives trading on the
underlying asset?
Main findings
The underlying stocks are
traded significantly more after
the introduction of warrants,
and the stocks are traded
more extensively when the
warrant speculation is more
severe.
The increased stock trading
cannot be fully explained by
reasons such as information
and hedging.
The spillover effect is
intensified when the
divergence of investors’ beliefs
is more pronounced.
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Our explanation
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Resale option theory
• Our results suggest that the resale option value of stocks increases with warrant bubbles
•Resale option theory
• Miller (1977), Harrison and Kreps (1978), and Scheinkman and Xiong (2003)
• Two conditions: Heterogeneous beliefs and short-sale constraint
• Overvaluation
The links
Heterogeneous
beliefs
A lack of knowledge about warrants contributes to the dispersion of beliefs
among stock investors. (Harris and Raviv (1993) and Kandel and Pearson
(1995))
Limited attention caused by warrants introduction. (Sims (2003),
Hirshleifer and Teoh (2003), Peng and Xiong (2006), Barber and Odean
(2008), Hou, Peng, and Xiong (2009), Yuan (2008))
Short-sale
constraint
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Empirical investigation
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Data I
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Source
• WIND
• We collect the complete observations of 50 warrants that are listed in Shanghai Stock
Exchange and Shenzhen Stock Exchange between August 2005 and June 2008
Variables
• Warrant: warrants turnover, IPD, duration, covered or not, put dummy, etc…
• Stock: stock turnover, liquidity, size, etc…
• Market turnover, industry
• Turnover and IPD are de-trended
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Data II
Mainland vs. Hong Kong
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Data III
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The Introduction of warrants I
Methodology
• Event study
• We formulate three pre-event periods, i.e., (-45, -15), (-90, -30), and (-180, -30), and
•three symmetric post-event periods around event day 0.
Result I
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The Introduction of warrants II
Result II
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Speculation spillover
Methodology
• A pooling regression
•
Result
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Information and hedging
Concerns
• Information: put warrants might convey negative information
• Hedging purpose: hedge ratio
Result
• Coefficients before put dummy are significantly negative
• Hedge ratio has positive sign
• Still, IPD and warrants turnover are significantly positive
• Why not a sample with no concern of information and hedging?
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Deep-out-of-the-money put warrants
Advantage
• Warrants prices contain no information at all.
• The change of hedge ratio is always zero.
Result
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Behavioral explanation
Test of the resale option story
• If the story of the resale option holds, where should we see stronger speculation
spillover effect?
• Smaller asset float: Hong, Scheinkman and Xiong (2006) develop a model to show
that asset float (the number of tradable shares) has a large effect on the size of
bubble. The implication is that there exists a negative relationship between resale
option value and asset float.
• Bull/Bear market: When the market is dominated by optimistic investors, it is
easier to drive out pessimists. The resale option value is higher (Harrison and
Kreps (1978), Morris (1996), Scheinkman and Xiong (2003), and Hong,
Scheinkman and Xiong (2006)).
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Behavioral explanation: asset float
Result
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Behavioral explanation: market sentiment
Result
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Conclusion
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Conclusion
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Main Findings
• We find a speculation spillover effect between warrants
market and stock market
• We argue that the speculation spillover may be the result
of increased behavioral biases in stock trading introduced
by the warrant bubble.
• Our study provides a test of the resale option theory by
examining the exogenous influence of warrant
speculations on stock trading.
• Our findings encourage more discussion on the design of
financial derivatives in the financial market.
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Thank you
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