Do the prices of stock index futures in Asia overr

DothepricesofstockindexfuturesinAsiaoverreacttoU.S.marketreturns?AlexanderKwok-WahFung⁎,KinLam1,Ka-MingLam2DepartmentofFinanceandDecisionSciences,HongKongBaptistUniversity,KowloonTong,HongKongarticleinfoabstractArticlehistory:Accepted16December2009Availableonline4January2010WeextendtheoverreactionstudytointeractionofinternationalmarketsandfindthatintradaypricereversalsexistinAsianindexfuturesmarketsfollowingextrememovementinU.S.market.Profitableopportunitiesexistafterconsideringtransactioncost.Weshowthatthereversalcannotbeexplainedbyrationalargumentssuchasrisk,liquidityandbid-askspread.Wefurtherobservethatamagnitudeeffectexists.Overreactionismoreprominentinthelatterperiodthanintheinitialperiod.Aftercalm-downperiods,overreactionisgreatlyreduced.Theseobservationssupporttheexplanationthatthesourceofpricereversalsliesinbehavioralbiases.©2009ElsevierB.V.Allrightsreserved.JELclassification:G14G15Keywords:BehavioralfinanceOverreactionAsianfuturesmarketsInternationalfinanceInvestors'sentiment1.IntroductionThisstudyexaminestheextenttowhichinvestorsintheAsianmarketshaveactuallyoverreactedindeterminingtheopeningpricesofindexfuturescontracts.Specifically,weinvestigateAsianmarkets'responsefollowingalargerise/dropintheU.S.market.Ourmotivationforthepaperisotherstudiesinoverreactionandstudiesonthestructureofinterdependenceininternationalstockmarkets.OurworkissimilartoEngleetal.(1990)inthatweallinvestigatetheeffectsofU.S.onAsianmarketsandfindthattherelationshipexists.However,whiletheylookatthevolatilityspilloverofforeignexchangemarketsinTokyoandNewYork,welookattheoverreactionofAsianindexfuturesmarketstopricemovementinU.S.Moreover,weshowthatthereisamagnitudeeffectinsuchoverreaction.BesslerandYang(2003)useanerrorcorrectionmodeltoinvestigatetheinterdependenceofinternationalstockmarkets.TheyfindoutthattheU.S.marketistheonlymarketthathasaconsistentlystrongimpactonpricemovementsinothermajorstockmarkets.EunandShim(1989)demonstratethattheU.S.marketleadsotherworldmarkets.ThesefindingsmotivateustoinvestigatethereactionofAsianindexfuturesmarketstotheU.S.stockmarketperformance.Wellknowntopractitionersandfinanceresearchers,AsianmarketsthatopenaftertheU.S.marketscloseareexpectedtofollowtheU.S.trend.Accordingtotheefficientmarkethypothesis,sincethemostrecentperformanceoftheU.S.marketisapieceofpublicinformationeasilyassessabletoAsianinvestors,thepricediscoveryprocessatmarketopenshouldJournalofEmpiricalFinance17(2010)428–440⁎Correspondingauthor.Tel.:[phone];fax:[phone].E-mailaddresses:[e-mail](A.K.-W.Fung),[e-mail](K.Lam),[e-mail](K.-M.Lam).1Tel.:[phone];fax:[phone]Tel.:[phone];fax:[phone]-5398/$–seefrontmatter©2009ElsevierB.V.Allrightsreserved.doi:10.1016/j.jempfin.2009.12.006ContentslistsavailableatScienceDirectJournalofEmpiricalFinancejournalhomepage:findingsconfirmthatthereisapricereversalinAsianindexfuturesmarketsfollowingextrememovementsintheU.S.market.Itiswellacceptedthatinvestors'overreactionwillleadtosubsequentpricereversal.Butitbecomescontroversialtolinkreversaltoinvestors'overreaction.Forstudiesinwhichthetriggeringeventofinvestors'reactionisnotidentified,thislinkagebecomesevenlesscertain.InSection2.1,wediscusswhetherreversalislinkedtoinvestors'overreaction.WethendiscussinSection2.2whetherthereversalislinkedtoinvestors'psychologicalbiases.2.1.Isreversallinkedtoinvestors'overreaction?Inthepresentstudy,wechoosetoinvestigatetheeffectofU.S.priceswingsonAsianmarketperformanceforthefollowingreasons.(1)ToanAsianmarket,theU.S.marketperformanceisbasicallyanexogenousevent.Hence,itsimplifiestheestablishmentofalinkagebetweenpricereversalsandoverreaction.(2)Comparedtootherexogenousevents,theonewechooseisverypreciseinitscontentandtimeofarrivaltothemarket.Theintensityoftheeventcanalsobemeasuredaccurately.Thisenablesustotestthesecondpartoftheoverreactionhypothesiswhichstatesthatthemoreextremetheeventis,thelargertheoverreactionis.(3)TheperformanceoftheU.S.marketiswidelyknowntotheinvestmentpublicinAsia.Evenindividualinvestorscanobtainthisinformationfromthelocalmorningnewsonatimelybasiswithnocost.Hence,overreactioncausedbythisexogenouseventislesslikelytobecausedbydifferentialinformationsetsamonginvestors.(4)Theexogenouseventhappensregularlyonadailybasis.Sinceourstudyspansaperiodoffiveormoreyears,wehaveplentyofobservations,andthetimetrendofoverreaction,ifany,canbestudied.Moreover,thetriggeringeventsoccuralmosteverytradingday.Ifinvestorsarerational,theyshouldlearnfromitandcorrecttheirmistakesverysoon.Thefactthatoverreactionexistsforalongperiodoftime,especiallyinthelatterperiod,showsthatinvestorsmayhavedifficultyincontrollingtheirreactionscausedbyemotion.(5)Wechoosetostudytheexogenousevent'simpactonfuturespricesratherthanoncashpricesbecausethefuturespricesareknowntoleadcashprices.Also,sincetransact