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

18 Pages Posted: 26 Feb 2016

See all articles by Ephraim Clark

Ephraim Clark

Middlesex University Business School

Zhuo Qiao

University of Macau

Wing-Keung Wong

Asia University, Department of Finance

Date Written: April 2016

Abstract

This article considers four utility functions - concave, convex, S‐shaped, and reverse S‐shaped - to analyze the behavior of different types of investors on the Taiwan stock index and its corresponding index futures. Using stochastic dominance (SD) rules, we show that the existence of all four investor types is plausible. Risk averters prefer spot to futures, whereas risk seekers prefer futures to spot. Investors with S‐shaped utility functions prefer spot (futures) to futures (spot) when markets move upward (downward). Investors with reverse S‐shaped utility functions prefer futures (spot) to spot (futures) when markets move upward (downward). We show that both spot and futures markets can exist when only risk averters are present, but futures can dominate spot only if there is some risk‐seeking behavior. These results are robust with respect to subperiods, spot returns including dividends, and diversification.

JEL Classification: C14, G12, G15

Suggested Citation

Clark, Ephraim and Qiao, Zhuo and Wong, Wing-Keung, Theories of Risk: Testing Investor Behavior on the Taiwan Stock and Stock Index Futures Markets (April 2016). Economic Inquiry, Vol. 54, Issue 2, pp. 907-924, 2016, Available at SSRN: https://ssrn.com/abstract=2738275 or http://dx.doi.org/10.1111/ecin.12288

Ephraim Clark (Contact Author)

Middlesex University Business School ( email )

The Burroughs
London, NW4 4BT
United Kingdom

Zhuo Qiao

University of Macau ( email )

P.O. Box 3001
Macau

Wing-Keung Wong

Asia University, Department of Finance ( email )

Taiwan
Taiwan

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