Behavioural Finance, Options Markets and Financial Crises: Application to the UK Market 1998-2010

Abstract

Behavioural Finance, Options Markets and Financial Crises: Application to the UK Market 1998-2010
By Ian Alan Whitfield
Abstract
This thesis examines the relationship between behavioural finance and options markets. Particular focus is on the analysis of option prices, implied volatility and trading activity which in turn provides insights into predictability, momentum and overreaction.
The thesis is contextualised by a general to specific evaluation of the literature that forms the basis of the behavioural finance paradigm. The review is extended to analyse the extent to which support for the behavioural finance approach has been produced by research on options. Behavioural finance retains an element of controversy as it runs counter to a key pillar of neoclassical finance, the efficient markets hypothesis. Hence the onus is on researchers in this field to produce evidence that refutes the notion of market efficiency and to build models with testable implications that are better able to capture the mechanics of financial markets.
This thesis is motivated by a desire to investigate, in detail, key aspects of human behaviour and to test whether they are particularly apparent in options markets. It is important to study the information which can be extracted from options data and to analyse whether this has any predictive power for spot prices. By extension, it is of further interest to examine whether movements in spot prices exert influence on option prices. In particular, aspects of options that capture human behaviour such as pricing of puts relative to calls, implied volatility, trading volume and open interest. The topical relevance of the work is highlighted by thorough application to the UK market during two recent periods of intense financial turbulence; the bursting of the dotcom bubble in 2001 and the liquidity/banking crisis of 2007/8.
The empirical work examines the pricing of exchange-traded options relative to theoretical values, the forecasting performance of implied volatility indexes, the ability of trading volume and open interest to capture behavioural aspects of trading behaviour, and momentum and overreaction effects. Hence the work provides a unique and thorough investigation into behavioural finance and options markets in the UK. Results indicate an important role for investor sentiment although they do not necessarily indicate exploitable inefficiencies.