Darwin Choi

The Role of Surprise: Understanding Overreaction and Underreaction to Unanticipated Events using In-Play Soccer Betting Market

Previous research in finance has found evidences of both overreaction and underreaction to unanticipated events, but has yet to explain why investors overreact to certain events while underreacting to others. In this paper, we hypothesize that while market participants generally underreact to new events due to conservatism, the extent of underreaction is moderated by “surprise,” thus causing market participants to overreact to events that are highly surprising. We test our hypothesis using data from an in-play soccer betting market, where new events (goals) are clearly and exogenously defined, and the degree of “surprise” can be directly quantified (goals scored by underdogs are more surprising). We provide both statistical and economic evidences in support of our hypothesis.We test the relationship between over-(under)reaction to news and the degree of surprise. Investors/bettors generally rely too heavily on prior beliefs and underreact, but sufficiently surprising information may cause overreaction due to the salience of the news. We use data from in-play soccer betting, where the arrival of information (goals) is well defined and the degree of surprise can be quantified. We find that bettors underreact to most goals, but overreact to highly surprising goals scored by “underdogs.” Our analysis suggests that overand underreactions are subsequently corrected, and a profitable betting strategy could be formed based on the biases.

Attention to Global Warming

We find that people revise their beliefs about climate change upward when experiencing warmer than usual temperatures in their area. Using international data, we show that attention to climate change, as proxied by Google search volume, increases when the local temperature is abnormally high. In financial markets, stocks of carbon-intensive firms underperform firms with low carbon emissions in abnormally warm weather. Retail investors (not institutional investors) sell carbon-intensive firms in such weather, and return patterns are unlikely to be driven by changes in fundamentals. Our study sheds light on peoples’ collective beliefs and actions about global warming.

Evaluating Regulators: The Efficacy of Discretionary Short Sale Rules

We examine the efficacy of short sale regulations in Hong Kong, where the list of shortable stocks is managed by regulators and is updated quarterly. While regulators generally cautiously restrict short selling to larger stocks, we show evidence of deviations: some large liquid stocks, which appear to satisfy the regulators’ stated selection criteria, are excluded from the list. In the absence of short sellers, these stocks earn positive excess returns after the list is made publicly available; such price impacts possibly represent an unintended consequence of the short sale regulations. We also find that the likelihood of large liquid stocks being excluded from the list increases in the ownership by Chinese institutions. Overall, our findings suggest that regulatory interventions should be made more transparent to maintain price efficiency.

Price Discovery under Disposition Sales

This paper studies the impact of the disposition effect, which results in uninformed sales when investors realize their capital gains. Using a microstructure model with anonymous trading, I show that market makers post tighter bid-ask spreads and quote prices that are less sensitive to sales for stocks trading at capital gains, as they rationally anticipate uninformed sales due to the disposition effect. Empirically, for firms with positive stock returns on merger and acquisition announcement dates, which could trigger disposition sales, I find evidence that a proxy for aggregate unrealized capital gains is related to liquidity improvements and decreased price impact; such relationships are not observed among firms with negative returns on announcement dates.