Over-and Under-Reaction in Option MarKets: Evidences from USD/KRW OTC Currency Options

This study investigates the over- and under-reacting behavior of USD/KRW OTC currency option investors from the year of 2006 to 2011. Using the empirical testing models suggested by Poteshman (2001), we first find that USD/KRW OTC option investors tend to under-react to the unexpected changes in instantaneous variances, which means ‘short horizon under-reaction’. Second, we find that USD/KRW OTC option market tends to slightly over-react to a long period of mostly positive (or negative) unexpected changes in instantaneous variances during the period of before global financial crisis in 2008, We find, however, that this ‘long horizon over-reaction’ in the aforementioned period is not statistically significant. Third, we find that the market tends to significantly under-react, rather than over-react, to a long period of mostly positive (or negative) unexpected changes in instantaneous variances during the period of after global financial crisis in 2008. Finally, using the different empirical testing model (i.e., model-free approach), suggested by Jiang and Tian (2010), we also obtained the same empirical results, which strengthen the robustness of them.