Investor Beliefs and the Demand Pressure on Index Options in Taiwan

Abstract

The effects of demand pressure on option prices have already been well documented within the extant literature; however, little appears to be known with regard to where the demand pressure on options originates. We set out in the present study to examine the ways in which investor beliefs affect the demand pressure on TAIEX options, employing forward-looking risk-neutral index distributions to evaluate such beliefs. Our examination of 2005–2012 high-frequency data reveals that with an increase in the level of market fear amongst investors, there will be a corresponding rise in the demand for options, with greater pessimism amongst investors resulting in weaker (stronger) demand for calls (puts). Furthermore, during the 2008 financial crisis, the soaring market atmosphere, and the fears of a market crash which soon followed, clearly had dominating effects on demand pressure, with an increase (reduction) in demand pressure for call (put) options being discernible during the bullish sentiment period, and vice versa amid the subsequent fears of a market crash.