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

Author Info

  • 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)

Registered author(s):

Abstract

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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Keywords: dynamic prospect theory; risk taking; market makers; options markets;

References listed on IDEAS
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  1. Gervais, Simon & Odean, Terrance, 2001. "Learning to be Overconfident," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 1-27.
  2. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
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  4. Nicholas BARBERIS & Ming HUANG & Tano SANTOS, 2000. "Prospect Theory and Asset Prices," FAME Research Paper Series rp16, International Center for Financial Asset Management and Engineering.
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  8. Joshua D. Coval & Tyler Shumway, 2005. "Do Behavioral Biases Affect Prices?," Journal of Finance, American Finance Association, vol. 60(1), pages 1-34, 02.
  9. Barber, Brad M. & Odean, Terrance & Zhu, Ning, 2009. "Systematic noise," Journal of Financial Markets, Elsevier, vol. 12(4), pages 547-569, November.
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  11. Gneezy, U. & Kapteyn, A. & Potters, J.J.M., 2002. "Evaluation Periods and Asset Prices in a Market Experiment," Discussion Paper 2002-8, Tilburg University, Center for Economic Research.
  12. Lucy F. Ackert & Narat Charupat & Bryan K. Church & James Tompkins & Richard Deaves, 2003. "An experimental examination of the house money effect in a multi-period setting," Working Paper 2003-13, Federal Reserve Bank of Atlanta.
  13. Nicholas Barberis & Ming Huang & Richard H. Thaler, 2006. "Individual Preferences, Monetary Gambles, and Stock Market Participation: A Case for Narrow Framing," American Economic Review, American Economic Association, vol. 96(4), pages 1069-1090, September.
  14. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  15. Brad M. Barber & Terrance Odean & Ning Zhu, 2009. "Do Retail Trades Move Markets?," Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 151-186, January.
  16. Chip Heath & Steven Huddart & Mark Lang, 1999. "Psychological Factors And Stock Option Exercise," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 601-627, May.
  17. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
  18. Thaler, Richard, 1980. "Toward a positive theory of consumer choice," Journal of Economic Behavior & Organization, Elsevier, vol. 1(1), pages 39-60, March.
  19. Battalio, Raymond C & Kagel, John H & Jiranyakul, Komain, 1990. " Testing between Alternative Models of Choice under Uncertainty: Some Initial Results," Journal of Risk and Uncertainty, Springer, vol. 3(1), pages 25-50, March.
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Cited by:

  1. Pikulina, E.S. & Renneboog, L.D.R. & Ter Horst, J.R. & Tobler, P.N., 2013. "Bonus Schemes and Trading Activity," Discussion Paper 2013-030, Tilburg University, Center for Economic Research.
  2. repec:dgr:kubcen:2013030 is not listed on IDEAS
  3. Vidal-García, Javier & Vidal, Marta, 2014. "Seasonality and idiosyncratic risk in mutual fund performance," European Journal of Operational Research, Elsevier, vol. 233(3), pages 613-624.
  4. Chou, Robin K. & Wang, Yun-Yi, 2011. "A test of the different implications of the overconfidence and disposition hypotheses," Journal of Banking & Finance, Elsevier, vol. 35(8), pages 2037-2046, August.
  5. Desmond Lam & Bernadete Ozorio, 2013. "The effect of prior outcomes on gender risk-taking differences," Journal of Risk Research, Taylor & Francis Journals, vol. 16(7), pages 791-802, August.
  6. Huang, Yu Chuan & Chan, Shu Hui, 2014. "The house money and break-even effects for different types of traders: Evidence from Taiwan futures markets," Pacific-Basin Finance Journal, Elsevier, vol. 26(C), pages 1-13.
  7. Hsu, Yuan-Lin & Chow, Edward H., 2013. "The house money effect on investment risk taking: Evidence from Taiwan," Pacific-Basin Finance Journal, Elsevier, vol. 21(1), pages 1102-1115.

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