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Prior Consequences and Subsequent Risk Taking: New Field Evidence from the Taiwan Futures Exchange

  • Yu-Jane Liu

    ()

    (Department of Finance, Guanghua School of Management, Peking University, Beijing 100871, People's Republic of China)

  • Chih-Ling Tsai

    ()

    (Graduate School of Management, University of California, Davis, Davis, California 95616)

  • Ming-Chun Wang

    ()

    (National Kaohsiung First University of Science and Technology, Kaohsiung 81164, Taiwan)

  • Ning Zhu

    ()

    (Graduate School of Management, University of California, Davis, Davis, California 95616; and Shanghai Advanced Institute of Finance (SAIF), Shanghai 200030, People's Republic of China)

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We use a data set from market participants in the Taiwan Stock Exchange Capitalization Weighted Stock Index options markets to demonstrate a strong positive relationship between prior trading outcomes and subsequent risk taking. In particular, investors in this market take above-average risks in afternoon trading after morning gains. The phenomenon is prevalent in all three types of market makers' accounts and across different types of market participants. Our findings are consistent with the argument that prior outcomes affect subsequent risk taking through a relationship that is sensitive to the model parameters (i.e., expected return, trading period, and curvature of the value function), because prospect theory can predict both increased and decreased levels of subsequent risk taking. We provide possible explanations behind the phenomenon and discuss reasons for the variety of findings in the existing literature.

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File URL: http://dx.doi.org/10.1287/mnsc.1090.1131
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Article provided by INFORMS in its journal Management Science.

Volume (Year): 56 (2010)
Issue (Month): 4 (April)
Pages: 606-620

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Handle: RePEc:inm:ormnsc:v:56:y:2010:i:4:p:606-620
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