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

29 Pages Posted: 28 Nov 2017 Last revised: 4 Dec 2017

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: November 23, 2017

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 Sshaped 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

JEL Classification: C14; G12; G15

Suggested Citation

Clark, Ephraim and Qiao, Zhuo and Wong, Wing-Keung, Theories of Risk: Testing Investor Behaviour on the Taiwan Stock and Stock Index Futures Markets (November 23, 2017). Available at SSRN: https://ssrn.com/abstract=3076338 or http://dx.doi.org/10.2139/ssrn.3076338

Ephraim Clark

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 (Contact Author)

Asia University, Department of Finance ( email )

Taiwan
Taiwan

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