Short-term contrarian and sentiment by traders’ types on futures markets

Purpose The purpose of this paper is to investigate whether the interaction between sentiments and past prices can lead to higher abnormal profit in futures markets. Such examinations allow the authors to relate the paper to the debate that focuses on examining the behavior of different types of traders in futures market, and who among these traders destabilize the markets. Design/methodology/approach First, the authors develop new dynamic strategies in US futures market that combine sentiment by type of traders based on trader position provided by the Disaggregated Commitments of Traders with short-term contrarian signals. Next, the authors adjust the abnormal profits to the CAPM model and Miffre and Rallis’s (2007) model. Finally, the authors use the Du (2012) decomposition methodology. Findings The main findings are that the abnormal profit is more pronounced when the authors combine past returns with lagged high producer/merchant/processor/user or low managed money sentiment. The results from swap dealer or other reportable groups show that there is no pervasive directional relation between their sentiment and contrarian profit. A further investigation of the sources of abnormal profits demonstrates that these profits survive even after the adjustment of obtained return to risk. Instead, these profits are mainly due to the overreaction to the news by irrational traders. Originality/value Based on behavioral finance theories, the authors conclude that producer, merchant, processor and user behave like irrational traders, while managed money traders behave like rational ones. Given that current regulatory proposes the limitation of speculation, the policy implications of these results are important. Therefore, these findings suggest that policy distinctions on trading motives may be more challenging to construct than ever.

On the survival of earnings fixated traders in an informational environment

Purpose The purpose of this paper is to examine the long-run survival of earnings fixated traders. Design/methodology/approach This paper builds a theoretical model of a competitive securities market where both rational traders and earnings fixated traders receive an informational signal about the asset payoff before any trade occurs. Since earnings fixated traders underestimate the mean and variance of the risky asset payoff, earnings fixated traders is shown to make less expected profits than rational traders. Findings If traders’ types replicate according to the relative profitability of their trading strategies, then earnings fixated traders will disappear in the long run. The results of this paper provide analytical support to Tinic’s (1990) intuition about the eventual disappearance of earnings fixated traders. Research limitations/implications In the literature, the underestimation of risk is popularly viewed as the cause of irrational traders being better able to exploit the misvaluations (created by noise traders) than rational traders. Hence, it favors the survival of irrational traders over rational traders. However, this paper disapproves this intuition in the informational environment of the competitive securities market. Practical implications The market environment plays a crucial role in determining the long-run survival of irrational traders. Originality/value This paper is the first to present a theoretical result showing that in this informational environment of the competitive securities market, the underestimation of risk by irrational traders does not give them advantage over rational traders in exploiting the misvaluations (created by noise traders) as it does in Callen and Luo (2011) and Hirshleifer and Luo (2001).

Survival of Overconfidence in Currency Markets

This paper tests the influential hypothesis that irrational traders will be driven out of financial markets by trading losses. The paper’s main finding is that overconfident currency dealers are not driven out of the market. Dealers with extensive experience are neither more nor less overconfident than their junior colleagues. We set the stage for this investigation by providing evidence that currency dealers display two forms of overconfidence: They underestimate uncertainty, and they overestimate their professional success. This is notable because one might have expected the opposite: currency dealers face strong incentives for accuracy, they have access to comprehensive information, and they have extensive experience.