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Asian Review of Financial Research Vol.26 No.4 pp.417-446
The Effect of Individual Investor on Volatility Trading in the KOSPI 200 Index Options Market
Sun-Joong Yoon Assistant Professor, Dongguk Business School, Dongguk University-Seoul
So Jung Kim* Ph.D. Candidate, School of Business, Yonsei University
Key Words : Individual Investors,Volatility Trading,KOSPI 200 Index Options,Implied Volatility Mean-Reversion


In financial economics, it is assumed that individual and institutional investors behave differently in the market. While institutions are viewed as informed traders, individuals are considered as noise traders with psychological bias as in Kyle (1985) and Black (1986). In particular, Choe et al. (1999) and Kaniel et al. (2008) examine the difference of individual investor trading in stock markets and its impact on the dynamics of stock prices. Based on these works, this paper aims to show how individual investors affect volatilities as well as stock returns, and whether individuals are uninformed traders of volatility trading. Our study, however, differs from the previous studies in that we focus on options markets instead of stock markets. There are two reasons that we examine the behavior of individual investors in options market other than in the stock market. First, according to the previous studies individual investors' behavior in options markets is inconsistent with their behavior in stock markets. Individual traders heavily depend on the changes of past prices and prefer out-of-the money options that have a severe leverage effect, which is significantly different from institutional and foreign investors. These unique characteristics of individual investors in options markets have made us interested in looking into the relationship between individual investors and options markets. Second, the structure of options markets is, in nature, optimal for analyzing the effect of each type of investors. When studying its impact using stock returns, we have to pay much attention in order to adjust for the effects by various factors such as dividends and stock-splits. However, we an easily adjust the effect of underlying asset returns on option returns using the series of options with different strike prices and different maturities, thereby simplifying our research design. As well-known, volatility is the measure of the price level which is adjusted for the effect of underlying asset. In short, if stock trading is based on the prospect about the future direction of underlying asset prices, option trading is based on that about the future direction of volatility. Therefore, it is called volatility trading. Although this paper investigates the behavior of individual investors in stock markets based on the idea of Kaniel et al. (2008), it differs from the study. While it solely focuses on the role of individual investors as liquidity providers in stock markets, our paper deals with the change of volatility by the behavior of individuals in the options market. Thus the aim of this paper is to see whether their interpretation holds valid in the volatility trading in the options market. In this paper, we analyze the autocorrelation between implied volatilities, including implied volatility of at-the-money options, and VKOSPI 200 index which results from calculating one-month model-free implied volatility using out-of-the-money KOSPI 200 index options. In addition, we examine whether volatility changes can be explained by the intensity of the buying/selling of individual investors using regression analysis, even after adjusting for the mean reverting of implied volatilities. For our second study, we sort data into ten decile groups according to the intensity of the buying/selling of individuals as a proxy for trading imbalances. Decile 1 is the most intense selling period and decile 10 is the most intense buying period. Then we examine buying/ selling imbalances and trading patterns of individuals in terms of the trend in simultaneous and cumulative volatility changes of deciles 1 and 2 and deciles 9 and 10, prior to, current, and after trading week separately, and calculate t-statistics of cumulative volatility changes for testing significance. The main results of this paper can be summarized as follows. First, we find that implied volatility is mean-reverted and that as the intense buying by individuals increases, so do current and future implied volatilities. Second, the imbalance of volatility between intense buying and selling is analyzed for each decile. According to the results, volatility significantly increases when individuals become only intensely buying options, which is likely to be consistent with the fact that individuals are net buyers in options markets. Finally, we investigate volatility change prior to, current, and after trading week and recognize that individuals are volatility-momentum traders who tend to buy options after volatility increases. Also the results of the robustness test indicate that the effect of individual investors on volatility is still significant after controlling for the total volume of options and the realized volatilities of underlying assets. Therefore, we can conclude that the information contained in the intensity of individual buying and selling is independent of information contained in the total volume and realized volatility.
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