Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market
42 Pages Posted: 15 Aug 2000
There are 2 versions of this paper
Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market
Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market
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: Suggested Citation
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