1. Authors: Ying-I Lee Advisor: Wen-Liang Hsieh, Ph. D. Date: 7, November, 2012 Informed trading in after-hours stock market trading

2. Outline Introduction Hypothesis Data Methodology

3. Introduction (1/16) Many stock exchange in the world choose to open and close their futures, options, and spot markets at different times. Ex. Taiwan Taiwan stock exchanges(TX) → 9:00 am ~1:30 pm after-hours trading period from 2:00 pm to 2:30 pm. Taiwan futures markets(TAIEX futures) → 8:45 am~1:45 pm Taiwan options markets (TAIEX options) → 8:45 am~1:45 pm

4. Introduction (2/16) Many studies of market microstructure explore the information content of the price to find the price discovery during the trading period. A few studies focus on price during the pre-open period because the commonly belief is that the pre-opening quotes of investors do not contain any information. The price of the pre-open period is nonbinding because the investors can cancel or revise their orders before the opening the exchanges. The overnight valuation is uncertainty due to there is no trading activity in the overnight period, the preopening orders might be informative orders or noise orders.

5. Introduction (3/16) Biais, Hillion, and Spatt (1999) They posited the noise hypothesis and learning hypothesis to test the information content of the preopening quotes. The noise hypothesis is based on the pre-opening prices and order that do not contain information about the value of the security. The learning hypothesis is that the pre-opening prices are unbiased predictors of the value of the security at opening. Their empirical results showed that the noise and the learning hypotheses can not be rejected. The pre-opening period may contain information and performs price discovery.

6. Introduction (4/16) Cao, Ghysels and Hatheway (2000) They examines the Nasdaq market marker’s activities during the pre-opening period, and it uses the Nasdaq market makers’ pre- opening quotes as signals for price discovery. The empirical evidence indicates that Nasdaq dealers use crossed locked inside quotes to signal to other market markers which direction the price should move. They indicated that the pre-opening quotes contain information content and price discovery.

7. Introduction (5/16) Barclay and Hendershott(2001) They provide the weighted price contribution method which captures the relative importance of information-motivated traders versus liquidity-motivated trades. For liquidity-driven trades, the price changes tend to be temporary and negatively correlated over time imply low volatility or WPC. The information-driven trading should have a high volatility and WPC.

8. Introduction (6/16) This study posits hypothesis one. H1: There are more informed trading in the spot and derivate markets during the pre-open period.

9. Introduction (7/16) French and Roll (1986) The trading behavior of the investors depends on their public, private or noise information. The trading behavior of the investors may affect the price volatility in securities market. Biais, Hillion, and Spatt (1999) They pointed that the informed traders do not want to disclosure their information until the opening gets closer. The informed traders avoid losing the profit of the information so they do not want to disclosure the information. As their information is getting public, they will aggressively trade on their information

10. Introduction (8/16) Barclay and Hendershot (2003) They expect less information asymmetry in the post-close than in pre-open of the Nasdaq stock market. Using the PIN model, the result find that the informed trading is greater during the pre-open than during the post-close. This study posits hypothesis two. H2: The informed trading in the pre-open trading session is richer than the post-close trading session in the spot market.

11. Introduction (9/16) Numerous stock exchange all over the world open and close their derivate and spot markets at different times. The extended trading sessions of the derivate market that give the investors to adjust their position. Chang, Jain and Locke (1995) They examined that the trading pattern of the S&P500 index futures after the closing of the NYSE. Their results show that the overall volatility of the futures market is substantially reduced immediately after the cash market closes. They found that the futures prices have U-shaped pattern for the volatility.

12. Introduction (10/16) Fong and Frino (2001) They extended the work in Chang, Jain and Locke (1995) They analysis patterns intraday price volatility in the futures market when the NYSE closed. They found that the mini U-shaped pattern in the volatility of the futures market. The volatility of the futures market decrease after the close of the NYSE, and increase when the futures market close.

13. Introduction (11/16) Ho and Lee(1998) They examined that the trading pattern of the Hang Seng index futures during the post-extension period by the 15 minutes. They find the mini U-shaped pattern for the volatility in the Hong Kong futures market. Above all, the extended trading periods of the futures market usually have U-Shaped volatility pattern. The phenomenon which is price volatile might be caused by the investors adjust their position in the extended trading period.

14. Introduction (12/16) Hiraki, Maberly and Takezawa (1995) They investigated the difference of the pre-extension and post- extension period of the Osaka Nikkei index futures returns. They use residual of the GARCH(1,1) to catch the private information. The results point the extension trading sessions that contain private information. The return innovation for the extended trading hours of futures markets would contain private information, which can explain the spot market overnight returns.

15. Introduction (13/16) Cusing and Madhavan(2000) 、 Cheng, Jiang and Ng(2004) 、 Chan and Cheng(2009) The liquidity driven trading may cause the price reversals between the close return and subsequent open return in the futures markets. They suggested that the extension period of the index futures can explain next trading sessions of the spot market.

16. Introduction (14/16) French and Roll (1986) They pointed the price volatility in securities market can be caused by investor’s which depends on public, private, or noise information. Chan (2005) Chan examined public information, private information, or noise trading hypotheses in the extension of trading hours on the Hang Seng index futures. The public information has been include into asset price so that the public information might be induced volatility and decreased price errors. The private information affects prices through the trading of the informed traders so the private information may be increased trading volume. The noise trading hypothesis causes the trading price might be caused by the overreaction of the investors. They found that the investors trade with their private information during the pre-extension period on the futures market. The results indicated that reductions in the volatility of futures returns and insignificant change in pricing errors during the 15 minutes opening session.

17. Introduction (15/16) Foster and Viswanathan(1990) The informed traders would trade aggressively on their private information during the post-extension period if their private information would become public information. The informed traders seek to trade with liquidity traders when liquidity traders trade in order to minimize transaction cost. This study posits hypothesis three. H3: There is more informed trading in derivate markets during the stock market non-trading period.

18. Introduction (16/16) Chakravarty(2001) The orders was submitted by individual and institutional investors have different price responses. Chang, Hsieh, and Lai(2008) They points the foreign institutional investors that have predicative power on the underlying asset returns. This study posits hypothesis four. H4: The foreign institutional investors are likely to better informed during the spot market non-trading period.

19. Data (1/2) This article uses the minute-by-minute intraday data of TX, TAIEX futures, and TAIEX options. TX: the Taiwan Stock Exchange Capitalization Weighted Stock Index TAIEX futures: the Taiwan Stock Exchange Capitalization Weighted Stock Index Futures TAIEX options: the Taiwan Stock Exchange Capitalization Weighted Stock Index Options The sample period is from January 3, 2007 to June 30, 2008. The observations contain intraday price and transaction records that are collected from the Taiwan Economics Journal (TEJ), Taiwan Stock Exchange Corporation (TWEC), Taiwan Futures Exchange databases.

20. Data (2/2) The pre-opening trading period of the spot price → the Taiwan Stock Exchange Capitalization Weighted Stock Index formula by TWSE :the issued shares of each constituent of the current day : open price of the current day :the Capitalization Weighted Stock index of the current day

21. Methodology (1/3) Implied stock price → Put-Call-Parity The assumptions of the Black-Scholes model Normal distribution Price volatility is constant Hsieh et al.(2007) suggest that the Put-Call-Parity model of the Stoll(1969) is a suitable method to calculate the implied stock price. The Put-Call-Parity model is specified as:

22. Methodology (2/3) Weight Price Contribution (WPC) Barclay and Warner (1993) Measure the amount of information incorporated into stock prices during a given time period : the logarithmic return for stock : weighting factor of stock : the proportion of return on day attributed to period

23. Methodology (3/3) Probability of an informed trade Easley, Kiefer, and O’Hara (1996, 1997) Estimate the amount the ratio of informed traders The likelihood function The estimator

25. The End. Thank you for your listening.