Can financial innovation succeed by catering to behavioral preferences? Evidence from a callable options market

We examine the notion that financial products which cater to investors’ behavioral biases can yield high trading activity and thus be profitable for issuers. Our setting considers options with a callback feature, namely, callable bull/bear contracts (CBBCs). Such contracts have high skewness when cl...

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Bibliographic Details
Published inJournal of financial economics Vol. 128; no. 1; pp. 38 - 65
Main Authors Li, Xindan, Subrahmanyam, Avanidhar, Yang, Xuewei
Format Journal Article
LanguageEnglish
Published Amsterdam Elsevier B.V 01.04.2018
Elsevier Sequoia S.A
Subjects
Behavior
Bias
Callable bull/bear contract (CBBC)
Cumulative prospect theory
Finance
Financial innovation
Gambling
Innovations
Investors
Lotteries
Options markets
Profits
Prospect theory
Skewness
Stock market indexes
Trading
Gambling
D03
G13
G12
G23
Lotteries
Callable bull/bear contract (CBBC)
Cumulative prospect theory
Financial innovation
D81
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Summary:We examine the notion that financial products which cater to investors’ behavioral biases can yield high trading activity and thus be profitable for issuers. Our setting considers options with a callback feature, namely, callable bull/bear contracts (CBBCs). Such contracts have high skewness when close to callback and thus appeal to cumulative prospect theory preferences. CBBCs with high skewness earn negative average returns, and issuers’ gross profits vary positively with CBBC skewness. Over the 2009–2014 period, issuers earn gross profits of about $1.67 billion by trading CBBCs on the Hang Seng Index. These findings highlight the role of behavioral finance in financial innovation.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2018.01.010