Speculation Spillover

This paper demonstrates that investor irrationality can be contagious across markets. Studies addressing the pros and cons of opening derivatives markets have failed to pay sufficient attention to the roles of speculative activities. This paper investigates how trading activities that are unrelated to fundamentals affect the impact of derivatives on stock markets. By using unique data from the Chinese warrants market, we document that there are speculation spillovers in an unsophisticated individualdominated market. Our findings indicate that a higher turnover of underlying stocks is associated with higher unexpected warrants turnover and a larger price deviation of warrants from theoretical prices that cannot be fully attributed to better information revelation or hedging needs. We suggest that behavioral biases may contribute to the contagious speculation between warrants and stock markets. Our paper contributes the debate over derivatives by taking speculation behavior into account.