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Theories of Risk: Testing Investor Behaviour on the Taiwan Stock and Stock Index Futures Markets

Ephraim Clark, Zhuo Qiao and Wing-Keung Wong

MPRA Paper from University Library of Munich, Germany

Abstract: Investor behavior towards risk lies at the heart of economic decision making in general and modern investment theory and practice in particular. This paper uses both the mean-variance (MV) criterion and stochastic dominance (SD) procedures to analyze the preferences for four of the most widely studied investor types in the Taiwan stock and stock index futures market. We find that risk averters (concave utility function) prefer spot to futures, whereas risk seekers (convex utility function) prefer futures to spot. Our findings also show that investors with S-shaped utility functions prefer spot (futures) to futures (spot) when markets move upward (downward). Finally, our results imply that investors with reverse S-shaped utility functions prefer futures (spot) to spot (futures) when markets move upward (downward). These results are robust with respect to sub-periods, spot returns including dividends and diversification. Although we do not check whether risk averters, risk seekers, and investors with S-shaped and reverse S-shaped utility functions actually exist in the market, we do show that their existence is plausible. The implications of our findings on market efficiency and the existence of arbitrage opportunities are also discussed in this study.

Keywords: stochastic dominance; risk aversion; risk seeking; prospect theory; behavioral economics; stock index futures (search for similar items in EconPapers)
JEL-codes: C14 C15 G12 (search for similar items in EconPapers)
Date: 2016-04-18
New Economics Papers: this item is included in nep-cfn, nep-ore and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (42)

Published in Economic Inquiry 2..54(2015): pp. 907-924

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Related works:
Working Paper: Theories of Risk: Testing Investor Behaviour on the Taiwan Stock and Stock Index Futures Markets (2017) Downloads
Journal Article: THEORIES OF RISK: TESTING INVESTOR BEHAVIOR ON THE TAIWAN STOCK AND STOCK INDEX FUTURES MARKETS (2016) Downloads
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