Pulling the trigger or not: Factors affecting behavior of initiating a position in derivatives markets

The behavior of managers in initiating a derivatives market position brings to the surface an interesting phenomenon: sometimes managers initiate a position in derivatives markets (i.e., futures and options markets) and sometimes they do not, even though the price volatility of the underlying asset has not changed. The current (hedging) models might explain the phenomenon of derivatives position-initiating behavior by assuming changes in the manager’s risk attitude and in the volatility of the underlying asset. However, this explanation is not in line with the literature that suggests that risk attitude in a particular domain does not show strong changes within a short time frame. In this paper we try to solve this puzzle by providing a conceptual model that is able to explain the manager’s futures contract initiation behavior. The psychological reference price and the futures market price level at the manager’s decision moment play a key role in this model. The model is able to explain futures initiation behavior without assuming changing risk attitudes or changing price volatility. Using data from experiments obtained from personal computer-guided interviews conducted with 450 managers, the proposed model is tested with logistic regression on choice probabilities. The manager’s risk attitude, the ratio of the futures price level to the manager’s psychological reference price and the interaction between them, appear to explain the manager’s behavior in initiating a futures position. 2002 Elsevier Science B.V. All rights reserved. Journal of Economic Psychology 23 (2002) 263–278 www.elsevier.com/locate/joep Address: Department of Agricultural and Consumer Economics, University of Illinois at UrbanaChampaign, 326 Mumford Hall, MC-710, 1301 W. Gregory Drive, Urbana, IL 61801, USA. Tel.: +1-217244-1284; fax: +1-217-333-5538. E-mail address: [email protected] (J.M.E. Pennings). 0167-4870/02/$ see front matter 2002 Elsevier Science B.V. All rights reserved. PII: S0167-4870 (02 )00067-3 PsycINFO classification: 2229; 2340; 3920 JEL classification: C51; D21; G29