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Exercise to Lose Money? Irrational Exercise Behavior from the Chinese Warrants Market

Authors

  • Li Liao,

    1. Li Liao is a Professor at PBC School of Finance at Tsinghua University, Beijing, People's Republic of China
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  • Zhisheng Li,

    1. Zhisheng Li is a Professor at the School of Finance at Zhongnan University of Economics and Law, Wuhan, People's Republic of China
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  • Weiqiang Zhang,

    1. Weiqiang Zhang is a Postdoctoral Researcher in School of School of Economics and Management at Tsinghua University, Beijing, People's Republic of China
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  • Ning Zhu

    Corresponding author
    1. Ning Zhu is a Professor at Shanghai Advanced Institute of Finance (SAIF), Shanghai Jiaotong University, Shanghai, People's Republic of China, and UC Davis, Davis, California
    • Correspondence author, Shanghai Jiaotong University, Shanghai, People's Republic of China, and UC Davis, Davis, CA. Tel: +86-21-6293 2280, Fax: +86-21-6293 2310, e-mail: nzhu@ucdavis.edu

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  • We are very grateful to the anonymous brokerage firm for making available the data used in the study and answering questions related to the data. The authors benefited from comments from Charles Cao, Neil Pearson, seminar participants at SAIF, an anonymous referee, and Bob Webb (the editor). We acknowledge financial support from the Tsinghua-Citi Financial Research and Education Program. Liao, Zhang, and Zhu acknowledge Project 71232003 supported by NSFC. Li acknowledges project 71271214 and 70801063 supported by NSFC. Zhu acknowledges Project 70972009 and 70932002 supported by NSFC. All remaining errors are ours only.

Abstract

Using a market-level exercise data set and an individual-level trading data set between August 2006 and June 2009, this study examines the incidence of two types of irrational exercise behavior in the Chinese warrants market. We find that 121.64 million shares of warrants (0.64% of all warrants) were either exercised with an immediate loss or failed to be exercised, resulting in foregone risk-free profits. These irrational exercises caused warrant holders to lose over 717.79 million Yuan. Some of the irrational behavior can be attributed to “entertainment seeking” and the “T + 1” rule practiced in the Chinese security market, but the majority is attributed to warrant holders' ignorance and/or negligence of warrant mechanics. Our findings provide additional field evidence of clearly irrational exercise behavior in a derivatives market. We also find that investor education, information and guidance provision can mitigate the incidence of irrational exercise behavior significantly. © 2013 Wiley Periodicals, Inc. Jrl Fut Mark 34:399–419, 2014

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