Essays on Finance
Date Issued
2008
Date
2008
Author(s)
Shu, Hui-Chu
Abstract
This dissertation consists of three parts. In the first part, how investor mood fluctuations influence equity and bill markets is explored. The second part examines the influence of weather on investor sentiment and stock market returns in the Taiwan Stock Exchange. In the last part, we derive the optimal hedging positions in revenue and price futures markets, and compare hedging effectiveness for using either or both futures contracts. As behavioral finance becomes one of the mainstream theories, considerable research has attempted to link investor mood and financial decision-making. Given the extensive evidence of investor moods influencing asset prices, a theoretical perspective for explaining the influence of mood fluctuations on financial markets is still lacked. Therefore, the first part of this dissertation attempts to fill this gap by investigating how investor mood fluctuations affect equilibrium asset prices, expected returns and equity premiums with a general equilibrium asset-pricing model. By slightly modifying the Lucas (1978) model, we show that several empirical findings can be well interpreted from a theoretical perspective. Furthermore, we show that a slight fluctuation in investor mood may cause a violent fluctuation in equity markets, and hence suggest that taking into consideration of investor mood fluctuations can be better able to explain the over-volatility in financial markets. During last two decades, the relationship between weather and stock returns has attracted considerable attention. However, previous research regarding the effect of weather on stock returns has provided no consensus conclusion, maybe because whether weather actually affects investor sentiment and behavior has not been demonstrated. The assumption that weather influences stock prices via investor mood makes sense only if there is a clear association among weather, investor sentiment and stock market returns. Thus, the second part investigates the relationship between weather and stock returns, as well as between weather and investor sentiment. The weather variables examined consist of temperature, humidity, and barometric pressure. The empirical results show that the stock market returns and investor sentiment are significantly correlated with weather: the better the weather, the higher the returns and investor sentiment. Notably, this weather effect is more pronounced for individuals than for institutions. This finding supports the psychological argument that weather influences investor mood, which in turn alters investment behavior, and hence stock prices. Moreover, individual investors are found to be more likely to diverge from rationality in investment than are institutional investors. As agricultural producers and numerous downstream partners face both price and yield uncertainty, the most significant risk they face is revenue risk. How to remove revenue risk has become the central concern of related firms. In the third part, we analyze the optimal hedging decisions for firms and producers facing price and yield uncertainty, assuming price futures and revenue futures are available. Using mean- variance and minimum-variance approaches, we derive the exact solutions of optimal positions in both futures markets, and show that the correlation between idiosyncratic yield risk and systematic yield shock leads to a hedging role for revenue futures. Additionally, the optimal position in price futures market depends on the individual yield risk that is uncorrelated with systematic risk, and greater shocks of systematic yield risk on spot prices increase optimal price futures position while reduce optimal revenue futures position. In comparison, hedging with both futures is superior to using either future in reducing the variance of profit.
Subjects
investor sentiment
behavioral finance
weather effect
revenue futures
hedging strategy
Type
thesis
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