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Investor sentiment, trading behavior and stock returns

This article examines how investor sentiment and trading behaviour affect asset returns. By analysing the unique stock trading dataset of the Korean market, we find that high investor sentiment induces higher stock market returns. We also find that institutional (individual) trades are positively (negatively) associated with stock returns, suggesting the information superiority (inferiority) of institutional (individual) investors. Investor sentiment generally plays a more important role in explaining stock market returns than investor trading behaviour.

… One possible rationale for this argument is Timmermanns (2008) statement that linear models do not reflect investors learning processes or structural changes in the underlying data-generating process. Furthermore, as shown in Ryu,

and Yang and Zhou (2016), who reveal that investor sentiment af- fects asset returns, the behavioral characteristics of investors can complicate the relationship between macroeconomic shocks and stock returns. Thus, problems may arise if nonlinearity is not considered when modeling this relationship. …


This study investigates stock price movements in response to macroeconomic shocks, allowing for asymmetry in this relationship. Given Fersons (1989) finding that large and small stocks can exhibit different risk behaviors, we examine the behaviors of the KOSPI and KOSDAQ stock markets in response to changes in the price level, real interest rate, and real USD/KRW exchange rate using simple and nonlinear autoregressive-distributed lag (ARDL) models. We find that the long-run effects of macroeconomic shocks are relatively insignificant under the simple ARDL model, whereas a significant and negative long-run effect is found for almost every explanatory variablemarket pair under the nonlinear model. In addition, we find that the long-run effects of stock price shocks on macroeconomic variables are more significant under the nonlinear model. Overall, the results imply that it is difficult to identify the relationship between macroeconomic variables and stock price dynamics without considering asymmetry.

Investor sentiment, investor crowded-trade behavior, and limited arbitrage in the cross section of stock returns

We examine the interaction effects of investor sentiment, investor crowded-trade behavior, and limited arbitrage on the cross section of stock returns. This paper presents strong evidence to reveal that investor crowded-trade behavior will increase stock prices greatly (little) among stocks with positive (negative) investor sentiment; and investor sentiment will increase (not increase) stock prices among stocks with extreme seller-initiated (buyer-initiated) crowded-trade behavior. Furthermore, this paper finds that the benchmark-adjusted returns are positive among stocks with relatively positive investor sentiment and buyer-initiated crowded-trade behavior, and negative among stocks with relatively negative investor sentiment and seller-initiated crowded-trade behavior. Finally, this paper demonstrates that limited arbitrage plays more roles on stocks with pessimistic sentiment and seller-initiated crowded-trade behavior. Taken together, this paper confirms the combined effects of investor sentiment and investor crowded-trade behavior on the cross section of stock returns, and further explores the moderating effect of limited arbitrage.

Risk Compensation and Market Returns: The Role of Investor Sentiment in the Stock Market

We investigate the effect of investor risk compensation (IRC) on stock market returns and the role of investor sentiment in influencing the link between IRC and stock returns. Results reveal that current IRC has a significant and positive effect on stock returns while past IRC has a negative effect. Meanwhile, the positive effect of current risk compensation on stock returns is sustainable with different current sentiment states, while this effect is not associated with the current magnitude of sentiment. Regarding past risk compensation, its negative impact on stock return also exists with different signs of past investor sentiment while this effect is not related to the value of past investor sentiment. We discuss the implications of the findings.

Market Reform and Efficiency: The Case of KOSPI200 Options

The Korean government and exchange have identified a need to regulate excessive speculative trading and to protect domestic individual investors from foreign and professional traders. As such, they have proposed an options market reform that requires higher levels of margin accounts for options trading and that increases the basic options multipliers in the KOSPI200 options market. This study examines how this market reform affects the price disagreement and adjustment behaviors of the index options market. Our analyses indicate that the efficiency and information quality of out-of-the-money options trades have increased since the reform took effect.

Dynamic conditional relationships between developed and emerging markets

This study examines the dynamic conditional correlations between the US and Korean financial markets and identifies the determinants of those correlations using the VAR-DCC-MGARCH model. We find that the Global Financial Crisis (GFC) affects both countries. Although the shocks to the Korean market before the GFC are not shared by the US market, those to the US market after the GFC are shared by the Korean market. We also examine the determinants of the dynamic conditional relations between the US and Korean markets using domestic macroeconomic variables and US/Korean financial variables. The results indicate that the US financial variables are more significant than domestic macroeconomic variables and that they have become increasingly important over time.

International transmission of risk factor movements: The case of developed markets

Under the Carhart four-factor system, this study examines the international transmission mechanism among country-specific risk factors by focusing on the cross-border transmission of factor innovation. We find that international stock markets are interrelated with respect to market, size, value and momentum factors, and developed countries play different roles in each factor system. Moreover, the United States (US) plays a dominant role in the market factor system, with US innovations in terms of size and momentum factors being significantly transmitted to other markets, whereas its influence on the value factor seems marginal. The United Kingdom is found to be the most influential market in the size factor system. Finally, Japanese value factor innovations better explain Hong Kong variance than US value factor innovations. Our results indicate that international exposure to risk factors can be exploited to implement effective hedging strategies and manage globally diversified portfolio risks.

Do Domestic Institutional Trades Exacerbate Information Asymmetry? Evidence from the Korean Stock Market

We analyze a trading dataset from the Korean stock market, a representative and leading emerging equity market, to study the impact of domestic institutional trades on information asymmetry. Using the bidask spread as a proxy for the adverse selection cost imposed by information asymmetry, we empirically examine the relationship between domestic institutional trades and their corresponding bidask spreads. We find that bidask spreads tend to increase when the trading volume of domestic institutional investors is high, suggesting that such investors tend to aggravate information asymmetry as informed traders in the Korean stock market.

The Effect of Investor Sentiment on Stock Returns: Insight from Emerging Asian Markets

This paper investigates the link between investor sentiment and stock returns in emerging Asian markets. Two dimensions of sentiment are examined: stock specific sentiment and market wide sentiment. Using panel regression with firm fixed effects, we show that stock specific sentiment strongly and positively affects stock returns after controlling for firm characteristics. Overall, there is a positive relationship between market wide sentiment and returns but the relationship does not hold at the country level. For individual countries, we detect substantial country-to-country variations in the influence of market wide sentiment on returns. The evidence also suggests that stock specific sentiment may have a greater influence on returns than market specific sentiment. Furthermore, the effect of investor sentiment on stock returns in emerging Asian markets generally persists after accounting for macroeconomic factors. © Asian Academy of Management and Penerbit Universiti Sains Malaysia, 2017.

Information asymmetry and investor trading behavior around bond rating change announcements

This study examines stock market reactions to public announcements (corporate bond rating changes), including changes in stock prices and investor behavior in terms of trading volumes and patterns. Abnormal returns, abnormal volumes, and net order imbalances are estimated using high-quality stock transaction data from Korean firms, whose bonds were rated by Koreas leading credit rating agencies between 2000 and 2015. We find positive (negative) abnormal stock returns around upgrades (downgrades), although the stock price reactions to downgrades are more statistically significant than those to upgrades. Significant abnormal volumes and order imbalances are found around rating changes, and the extent to which each investor group (domestic individuals, domestic institutions, or foreign investors) reacts to a rating change varies. Our analyses also support that foreign and domestic institutional investors are better informed than individual investors.

Investor sentiment, asset returns and firm characteristics: Evidence from the Korean Stock Market

This study investigates the effects of investor sentiment on asset returns with respect to firm characteristics. By analysing a unique stock trading dataset of the Korean Stock Market that contains rich information on investor types and sentiment, we confirm that high investor sentiment induces higher stock market returns. The positive association between investor sentiment and stock returns is highly significant after controlling for trading behaviours, other risk factors and firm characteristics. Interestingly, investor sentiment has stronger effects on small firm, low-priced, high book-to-market ratio, high excess return, and highly volatile stocks, and stocks heavily traded by individual investors. The diverse degree and intensity of the sentiment effect across stocks with different firm characteristics is possibly attributable to individual investors trading.

Option Market Characteristics and Price Monotonicity Violations: Option Price Monotonicity Violations

This study reexamines whether option price monotonicity properties hold in a liquid market with little market friction and considers the validity of the monotonicity properties in light of option market characteristics. We confirm that option prices do not monotonically correlate with underlying spot prices and that call and put prices often increase or decrease together, indicating that the monotonicity properties are not consistent with the observed option price dynamics. The violations of monotonicity properties are associated with not only market microstructure effects, trade sizes, and option leverage but also other market characteristics such as trade direction, individual investor demand, foreign investor trading, and market volatility. Violation occurrences tend to be clustered, and their relationship with option market characteristics has not been affected by the recent market reform. © 2016 Wiley Periodicals, Inc. Jrl Fut Mark

Investor Sentiment and Return Predictability of Disagreement

Informed Trading before Positive Vs. Negative Earnings Surprises

Investor Sentiment and the Cross-Section of Stock Returns

Global, Local and Contagious Investor Sentiment

Foreign investor trading and information asymmetry: Evidence from a leading emerging market

This article examines the influence of foreign investor trading on information asymmetry in the Korean stock market, a representative emerging market characterized by a high level of information asymmetry between corporate insiders and outsiders, and among investors. We find a significantly positive relationship between foreign investor trading and the consequent bidask spread the latter of which is considered as a proxy for the degree of information asymmetry on both daily and weekly bases. Our results indicate that active foreign investor trading tends to exacerbate informational variation.

Trade duration, informed trading, and option moneyness

This study shows the relationship between the price impact of a trade and the duration between trades by extending a trade indicator microstructure model. Using the intraday transaction data from the KOSPI 200 options market, one of the most famous and actively traded derivatives markets in the world, we find that the price impact is greater when the trade duration is shorter for in-the-money (ITM) options, while the correlation is opposite for out-of-the-money (OTM) options. Our finding that fast trading indicates informed (noisy) trading in the ITM (OTM) options remains unchanged despite controlling for the effects of trade volume, market liquidity, and intraday time periods. There are indications that the different compositions of informed and uninformed traders in terms of option moneyness cause this result. We also find that the information content of trade duration becomes greater when informed trading is more concentrated, liquidity is lower, option maturities are longer, and the market is more volatile.

The price impact of futures trades and their intraday seasonality

This study examines the price impact of futures trades and their intraday seasonality by analyzing the continuous trading session dataset of KOSPI 200 futures, including the opening and closing periods. For this purpose, the study analyzes the futures dataset that contains information on transaction times, trade directions, order sizes, and the types of investors initiating the transactions. The results suggest several novel findings. First, a substantial portion of the price impact of futures trades is persistent, indicating the presence of informed trading in the futures market. Second, informed trading is concentrated in the opening period and liquidity trading is concentrated in the closing period of the continuous trading session. Third, small trades usually have a greater price impact than large ones, supporting the existence of stealth trading by futures traders. Fourth, trades by institutional investors have a greater price impact than those by individuals, suggesting that institutional investors are better informed and/or more sophisticated than individual investors in the futures market.

Investor trading behavior, investor sentiment and asset prices

This paper examines the roles of investor trading behavior and investor sentiment on asset prices. We find that both the investor trading behavior and investor sentiment have significant effects on excess returns beyond the three factors of Fama and French (1993), and more importantly, the investor trading behavior has more significant impacts on excess returns than investor sentiment. Furthermore, the empirical results reveal that the impacts of investor trading behavior and investor sentiment on the excess returns of small stocks are greater than large stocks, which is failure to explain small stock returns in Fama and French (1993, 2012, 2015). Moreover, this paper demonstrates the term structure of investor sentiment effect and the term structure of investor trading behavior effect. Collectively, our findings support the roles of investor trading behavior and investor sentiment on the formation of excess returns.

How Wise Are Crowds? Insights from Retail Orders and Stock Returns

We analyze the role of retail investors in stock pricing using a database uniquely suited for this purpose. The data allow us to address selection bias concerns and to separately examine aggressive (market) and passive (limit) orders. Both aggressive and passive net buying positively predict firms monthly stock returns with no evidence of return reversal. Only aggressive orders correctly predict firm news, including earnings surprises, suggesting they convey novel cash flow information. Only passive net buying follows negative returns, consistent with traders providing liquidity and benefiting from the reversal of transitory price movements. These actions contribute to market efficiency.

Spread and depth adjustment process: An analysis of high-quality microstructure data

This study examines liquidity dynamics by observing changes in bid-ask spreads and market depths in response to new information and trading activities. By analysing high-quality data from the KOSPI200 futures market, we determine that spread and depth effectively adjust to new information and trading activities. Our empirical results indicate that the size of the equilibrium spread is positively related to trade frequency, the degree of informed trading, volatility and the relative portions of individual trades, and negatively related to trade size. We also find that equilibrium depth is positively associated with the trade frequency and volatility, and negatively associated with the informed trading.

Are individual investors less informed than institutional investors? Unique evidence from investor trading behaviours around bad mergers in Korean financial market

This article presents the trading behaviours of individual and institutional investors in Korean mergers and acquisitions market. Based on Chen et al. (2007), we consider a bidders negative abnormal announcement-period return as a measure for bad merger. To investigate the investor trading behaviours around the bad mergers, we employ a unique daily trading data of different groups of investors in Korean stock market. Our finding shows that institutional investors sell their shares on a bidding firm before announcement of a bad merger, while individual investors buy the shares. In addition, we find that institutional investors continue to sell their shares on a bidding firm even after announcement of a bad merger, but individual investors keep buying them. Hence, our results newly support the hypothesis that individual investors are less informed and/or less sophisticated than institutional investors.

Retail Investor Sentiment and Return Comovements

The Information Content of Trades: An Analysis of KOSPI 200 Index Derivatives

This study examines and compares the information content of futures and options trades by analyzing the transaction dataset of derivatives underlying the KOSPI 200 index. This dataset contains detailed information about investor types and trade directions. Previous market microstructure studies of Koreas index derivatives market (i.e., KOSPI 200 futures and options market) may contain model biases and microstructure errors because they depend on structural models and/or they focus on infinitesimal price changes between consecutive trades. In an effort to improve upon previous works, we use the simple regression approach described by Schlag and Stoll (2005, Price impacts of options volume. Journal of Financial Markets, 8, 6987) and examine the information content of trades by tracing the price impacts of the trades over successive intervals of time. We find that a significant proportion of the price impact attributed to futures trades is permanent and that the price discovery effect is larger in the futures market than in the options market. Institutional futures trades are generally more informative than individual trades, and trades made by foreign institutions have the greatest permanent price impact. Examination of the intertemporal relationship between futures and options trades also indicates that the futures trades generally lead the options trades. Overall our results suggest that futures trades contribute more to price discovery than do options trades and that futures trades made by foreign institutions are most informed while those of domestic individuals are least informed. © 2013 Wiley Periodicals, Inc. Jrl Fut Mark

Investor Herding Behaviour of Chinese Stock market

We analyze time series of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated with model-based expected returns. The evidence is not consistent with rational expectations representative investor models of returns.

Informed trading in the index option market: The case of KOSPI 200 Options

This study examines if informed trading is present in the index option market by analyzing the KOSPI 200 options, the most actively traded derivative product in the world. The spread decomposition model developed by Madhavan, Richardson, and Roomans (1997) is utilized and the adverse-selection cost component of the spread estimated by the model is then used as a proxy for the degree of informed trading. We find that adverse-selection costs constitute a nontrivial portion of the transaction costs in index options trading. Approximately one-third of the spread can be accounted for by information asymmetry costs. A further analysis indicates that adverse-selection costs are positively related with option delta. Our regression analysis shows that option-related variables are significantly associated with estimated information asymmetry costs, even when controlling for proxies for informed trading in the index futures market. Finally, we find the evidence that foreign investors are better informed compared to domestic investors and that domestic institutions have an edge in terms of information over domestic individuals. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:11181146, 2008

Which traders order-splitting strategy is effective? The case of an index options market

This study extends the recent study by Chae and Lee (2011)8. Chae , J. and Lee , E. J. 2011 . An analysis of split orders in an index options market . Applied Economics Letters , 18 : 473 7 . [Taylor & Francis Online], [Web of Science ®]View all references who empirically examine order-splitting and stealth-trading behaviours in the Korea Stock Price Index 200 (KOSPI200) options market, which is the single most liquid derivative market in the world. By analysing the high-quality data set, which identifies and describes all investors in the options market, we find that split orders submitted by institutional investors are substantially informative, whereas those of domestic individuals negatively contribute to the price discovery process. The inferiority of the order-splitting strategies of these individuals is more prominent when they trade deep Out-of-The-Money (OTM) options.

Intraday price formation and bid-ask spread components: A new approach using a cross-market model

This study examines the intraday formation process of transaction prices and bidask spreads in the KOSPI 200 futures market. By extending the structural model of Madhavan, A., Richardson, M., and Roomans, M. (1997), we develop a unique cross-market model that can decompose spread components and explain intraday price formation for the futures market by using the order flow information from the KOSPI 200 options market, which is a market that is closely related to the futures market as well as considered to be one of the most remarkable options markets in the world. The empirical results indicate that the model-implied spread and the permanent component of the spread that results from informed trading tend to be underestimated without the inclusion of options market information. Further, the results imply that trades of in-the-money options, which have high delta values, generally incur a more adverse information cost component (the permanent spread component) of the futures market than those of out-of-the-money options, which have relatively low delta values. Finally, we find that the adverse information cost component that is estimated from the cross-market model exhibits a nearly U-shaped intraday pattern; however, it sharply decreases at the end of the trading day. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark

Information Effects of Trade Size and Trade Direction: Evidence from the KOSPI 200 Index Options Market*

In the present study, we examine two important issues related to the information content of a trade in option markets: (i) whether trade size is related to information content; and (ii) whether buy and sell transactions carry different information content. Our analysis is based on comprehensive market microstructure data on the KOSPI 200 options, the single most actively traded derivative securities in the world. We use two structural models modified from the Madhavan et al. [Review of Financial Studies 10 (1997) 10351064] model, the size-dependent model (SDM), and the dummy variable model (DVM). The SDM incorporates trade size in the model to estimate the magnitude of the information content of a trade. The DVM separately estimates information contents for buyer- and seller-initiated trades using a dummy variable. Our SDM analysis reveals that large trades are in general more informative than small trades. The results from the DVM analysis indicate that buyer-initiated trades generally have greater information content than seller-initiated trades. A further analysis using investor-type information shows that the asymmetry in information content between buy and sell trades is mostly attributable to the orders submitted by foreign and domestic institutional investors.

The Short of It: Investor Sentiment and Anomalies

This study explores the role of investor sentiment in a broad set of anomalies in cross-sectional stock returns. We consider a setting where the presence of market-wide sentiment is combined with the argument that overpricing should be more prevalent than underpricing, due to short-sale impediments. Long-short strategies that exploit the anomalies exhibit profits consistent with this setting. First, each anomaly is stronger – its long-short strategy is more profitable – following high levels of sentiment. Second, the short leg of each strategy is more profitable following high sentiment. Finally, sentiment exhibits no relation to returns on the long legs of the strategies.

Investor Sentiment and the Near Term Stock Market

We investigate investor sentiment and its relation to near-term stock market returns. We find that many commonly cited indirect measures of sentiment are related to direct measures (surveys) of investor sentiment. However, past market returns are also an important determinant of sentiment. Although sentiment levels and changes are strongly correlated with contemporaneous market returns, our tests show that sentiment has little predictive power for near-term future stock returns. Finally, our evidence does not support the conventional wisdom that sentiment primarily affects individual investors and small stocks.

Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns

We use mutual fund flows as a measure of individual investor sentiment for different stocks, and find that high sentiment predicts low future returns. Fund flows are dumb moneyby reallocating across different mutual funds, retail investors reduce their wealth in the long run. This dumb money effect is related to the value effect: high sentiment stocks tend to be growth stocks. High sentiment also is associated with high corporate issuance, interpretable as companies increasing the supply of shares in response to investor demand.

We build a model that helps to explain why increases in liquiditysuch as lower bidask spreads, a lower price impact of trade, or higher turnoverpredict lower subsequent returns in both firm-level and aggregate data. The model features a class of irrational investors, who underreact to the information contained in order flow, thereby boosting liquidity. In the presence of short-sales constraints, high liquidity is a symptom of the fact that the market is dominated by these irrational investors, and hence is overvalued. This theory can also explain how managers might successfully time the market for seasoned equity offerings, by simply following a rule of thumb that involves issuing when the SEO market is particularly liquid. Empirically, we find that: (i) aggregate measures of equity issuance and share turnover are highly correlated; yet (ii) in a multiple r