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Speculation Spillovers. Outline. 1. Motivation. 2. Results. 3. Empirical Investigation. 4. Conclusion. Motivation. Derivatives. Stabilization. Destabilization. Derivatives traders are rational and sophisticated. The impact of derivatives. Low cost High margin High liquidity.

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Presentation Transcript
slide2

Outline

1. Motivation

2. Results

3. Empirical Investigation

4. Conclusion

slide4

Derivatives

Stabilization

Destabilization

Derivatives traders are rational and sophisticated

  • The impact of derivatives
  • Low cost
  • High margin
  • High liquidity
  • Danthine (1978)
  • Turnovsky (1983)
  • Etc…
  • Stein (1987)
  • Kraus and Smith (1996)
  • Etc…
slide5
WuLiang Put warrant

Source: Xiong and Yu (2010)

slide6
WuLiang Put warrant

Source: Xiong and Yu (2010)

6

slide7

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)
  • Heath et al. (1999), Poteshman (2001), Horst and Veld (2008), Haigh and List (2005), Liu, Wang, and Zhao (2010)
  • Behavioral bias exits in derivatives markets

Xiong and Yu (2010)

Other studies

7

slide9

The spillover effect is intensified when the divergence of investors’ beliefs is more pronounced.

  • What are the impacts of behavioral biases in derivatives trading on the underlying asset?
  • The increased stock trading cannotbe fullyexplained by reasons such as information and hedging.
  • 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.
  • Speculation spillovers

Research question

Main findings

slide10

Heterogeneous beliefs

  • 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
  • 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
  • Our explanation

Resale option theory

The links

slide12

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
  • 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
  • Data I

Source

Variables

slide13
Data II

Mainland vs. Hong Kong

13

slide15

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.
  • The Introduction of warrants I

Methodology

Result I

15

slide17

A pooling regression

  • Speculation spillover

Methodology

Result

17

slide18

Information: put warrants might convey negative information

  • Hedging purpose: hedge ratio
  • 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?
  • Information and hedging

Concerns

Result

18

slide19

Warrants prices contain no information at all.

  • The change of hedge ratio is always zero.
  • Deep-out-of-the-money put warrants

Advantage

Result

19

slide20

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)).
  • Behavioral explanation

Test of the resale option story

20

slide24
Conclusion

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 biasesin stock trading introduced by the warrant bubble.
  • Our study provides a test of the resale option theory by examining the exogenousinfluence of warrant speculations on stock trading.
  • Our findings encourage more discussion on the design of financial derivatives in thefinancial market.
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