Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market

42 Pages Posted: 15 Aug 2000

See all articles by Allen M. Poteshman

Allen M. Poteshman

University of Illinois at Urbana-Champaign - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: July 2000

Abstract

This paper investigates the response of option market investors to the information contained in daily changes in the instantaneous variance of the underlying asset. Evidence is provided that these investors exhibit (1) short-horizon underreaction to daily information, (2) long-horizon overreaction to extended periods of mostly similar daily information, and (3) increasing misreaction (along a scale that ascends from underreaction to overreaction) to daily information as a function of the quantity of previous similar information. The increasing misreaction can reconcile the short-horizon underreaction with the long-horizon overreaction and is also consistent with well-established cognitive biases.

Keywords: Underreaction, Overreaction, Behavioral Finance, Option Pricing, Stochastic Variance

JEL Classification: G13, G14

Suggested Citation

Poteshman, Allen M., Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market (July 2000). Available at SSRN: https://ssrn.com/abstract=236109 or http://dx.doi.org/10.2139/ssrn.236109

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