Clearly Irrational Financial Market Behavior: Evidence from the Early Exercise of Exchange Traded Stock Options

Poteshman, Allen M.; Serbin, Vitaly

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https://hdl.handle.net/2142/3794 Copy

Description

Title

Clearly Irrational Financial Market Behavior: Evidence from the Early Exercise of Exchange Traded Stock Options

Author(s)

• Poteshman, Allen M.
• Serbin, Vitaly

Issue Date

2001-08

Keyword(s)

• Prospect theory
• Options market

Abstract

This paper analyzes the early exercise of Chicago Board Options Exchange listed calls by different classes of investors over the 1996-1999 period. We present two main findings. First, there are a large number of early exercises that can be identified as clearly irrational without invoking any model of market equilibrium, and these exercises are not uniformly distributed across the investor classes. Customers of discount brokers and customers of full service brokers both engage in a significant number of irrational exercises while traders at large investment houses exhibit no irrational early exercise behavior. Second, irrational exercise is triggered both by the underlying stock price attaining its highest level over the past year and by the underlying stock having high past returns. Our findings provide evidence that prospect theory is operative in the options market and that it applies differentially across various classes of investors.

Publisher

Office for Futures and Options Research, Department of Agricultural Economics, College of Agricultural, Consumer, and Environmental Sciences at the University of Illinois at Urbana-Champaign

Series/Report Name or Number

OFOR Working Paper Series, no. 01-02

Type of Resource

text

Language

eng

Permalink

http://hdl.handle.net/2142/3794

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