Investor Overconfidence And Option Trading
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This study examines investor overconfidence theory in the options market. The theory suggests that investors who experience high returns become overconfident in their security valuation and trading skills, and therefore trade more often, even when the high returns are market wide. Given stock investors often trade in both stock and options market, I hypothesize similar patterns could be found in the options market as well. Controlling for market volatility and stock idiosyncratic risk, past market return is positively correlated with option trading turnover. In addition, past positive market return leads to higher call option turnover ratio and higher call-to-put ratio. These findings are consistent with the overconfidence hypothesis. In the second chapter, I further discuss the relationship between investor overconfidence and option pricing patterns, such as realized volatility, volatility spread, and volatility skew. I find option trading activities increase realized volatility and forwardlooking volatility measure (VIX). They also tend to make out-of-the-money call options more expensive relative to the at-the-money counterparts over time, but they are associated with less expensive out-of-money call options cross-sectionally. In addition, there is evidence showing option traders are contrarians.