The Impact of Trading Information in Derivative Markets on the

Korean Stock Market

Taehyuk Kim*
Jonghae Park**

Aejin Ha***

August 2011

*Corresponding Author. Professor of Finance, Dept. of Business Administration,

School of Business, Pusan National University, Pusan, South Korea.
E-mail: tahykim@pusan.ac.kr, Phone: +82-51-510-2562
** Assistant Professor, Dept. of Venture & Business, College of Business and
Economics, Gyoengnam National University, Gyoengnam, South Korea.
E-mail : jh0120@jinju.ac.kr, Phone: +82-55-751-3457
*** Post Doctor, Dept. of Business Administration, School of Business, Pusan
National University, Pusan, South Korea.
E-mail : ajha@pusan.ac.kr, Phone: +82-51-510-2562

Electronic copy available at: http://ssrn.com/abstract=1914282

The Impact of Trading Information in Derivative Markets on the

Korean Stock Market

ABSTRACT
This paper attempts to investigate the impact of transaction information formed in derivative markets on the
Korean stock market based on the notion that both institutional and foreign investors are smart traders who
trade securities on transaction information in derivative markets. To test our hypothesis that the impact of
transaction information in derivative markets is stronger on the stocks preferred by smart traders, we form
several portfolios sorted on firm size, price, book to market value, institutional ownership, and lottery type
features and examine the impact of transaction information in derivative markets on the respective portfolio
returns with the composed derivative index. This study reveals that the transaction information in derivative
market has greater impacts on the stocks preferred by smart traders (i.e., large firm, high priced, high BM,
high institutional ownership, and non-lottery type stocks).

.
Keywords: Transaction information in derivative markets; Informed trader; Smart trader; Institutional
investors' habitat

1. Introduction
It is widely known that transaction information in derivative markets affects price discovery
in spot market. Informed traders also prefer to trade derivatives rather than the underlying stocks
for reduced transaction costs, lack of short sales constraints, and increased financial leverage
(Black, 1975; Mayhew, Sarin, and Shastri, 1995). A number of studies support this assertion by
presenting that informed traders trade stocks depending on the trading information in derivative
markets such as implied volatility index (VIX), put-call volume ratio (PCR), put-call open interest
ratio (PCR), and the changes in net futures (Bandopadhyaya and Jones, 2008; Banerjee, Doran,
and Peterson, 2007; Dash and Moran, 2005; Easley, O'Hara, and Srinivas, 1998; Giot, 2005;
Kalok and Johnson, 1993; Kumar, Sarin, and Shastri, 1998, Wang, Keswani, and Taylor, 2006;
Whaley, 2000).
This paper takes as its starting point the proposition that both institutional investors and
foreign investors are smart traders who trade on transaction information in derivative markets
since they have private information and sophisticated analytical capabilities. This paper attempts
to investigate whether trading information in derivative markets affects price dynamics of stocks
which mostly preferred by smart traders. If informed traders trade based on the trading
information in derivative market, trading information would have greater impacts on the stocks
which mostly traded by informed traders. Hence, this study construct a composite derivative
index and investigate the impact of the derivative index on large, high priced, high BM, high
institutional ownership, and non-lottery type stocks.
In sum, the purpose of this study is to test the impact of trading information in derivate

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Electronic copy available at: http://ssrn.com/abstract=1914282

markets on the Korean stock market. This study contributes to the literature in that 1) it directly
tests the role of derivatives trading information in the stock market and 2) the information
formed in the derivative markets has stronger impacts on stocks with higher concentration of
smart traders.
The remainder of the study organized as follows. Section 2 describes the hypotheses. Section
3 discusses the samples and empirical methods employed in this study. Empirical results are
presented in Section 4. Finally, Section 5 provides brief concluding remarks.

2. The Hypotheses
Both institutional and foreign investors have better access to private information and more
sophisticated analytic skills than individual investors. This study attempts to analyze the impact of
trading information in derivative markets on the Korean stock market based on the assumption
that both institutional and foreign investors are smart traders who trade on information formed in
derivative markets. Specifically, this study tests below hypotheses based on investor habitat-based
model.
H1. The impact of information in derivative markets on the stocks of larger firms would be
stronger.
Informed traders prefer option tradings to underlying asset tradings once options on
underlying assets are listed (Kumar, Sarin, and Shastri, 1998). John, Koticah, and Subrahmanyam
(1993) assert informed traders migrate to option markets for reduced transaction costs and
increased financial leverage. If option markets are more attractive to informed traders, option
volumes and volatility carry information content for the future direction and volatility of
underlying asset prices. An abundance of studies also show that informed traders trade securities
on the transaction information such as VIX, put-call volume ratio (PCR), put-call open interest
ratio (PCO), changes in net futures, etc (Bandopadhyaya and Jones, 2008; Banerjee, Doran, and
Peterson, 2007; Dash and Moran, 2005; Easley, O'Hara, and Srinivas, 1998; Giot, 2005; Kalok
and Johnson, 1993; Kumar, Sarin, and Shastri, 1998; Wang, Keswani, and Taylor, 2006; Whaley,
2000).
Recent studies present empirical results related to investor habitat-based model. Barberis,
Shleifer, and Wurgler (2005) propose certain type of investors prefer stocks with certain
characteristics and investors trade within specific stock categories (i.e., habitat). Supporting their
findings, Kumar and Lee (2006) argue retail investors prefer small, high BM, low-priced, and
low institutional ownership stocks. Kumar (2009) also posits certain socioeconomic investors
express a preference for lottery-type stocks. He further finds out that individuals and institutional
investors exhibit roughly opposite preferences.
Based on previous works, one might well expect that the information in derivative markets
has greater impacts on larger firm stocks which are largely preferred by smart traders.
H2. The impact of information in derivative markets on the stocks with high price would be
stronger.

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Electronic copy available at: http://ssrn.com/abstract=1914282

Smart traders such as institutional and foreign investors exhibit a preference to large firm
stocks and the vast majority of large firm stocks are high-priced. We therefore hypothesize the
impact of information in derivative markets on the stocks with high price is stronger since smart
traders might concentrate their holdings in high-priced stocks.
H3. The impact of information in derivative markets on the stocks with high book to market
value would be stronger.
Kumar and Lee (2006) find out that the individual investors have a preference for high
book to market value (BM) while individuals and institutionals exhibit roughly opposite
preferences. Contrary to Kumar and Lee (2006)'s finding, Gompers and Metrick (2001) show that
institutional investors exhibit a strong preference for value stocks and Ko and Kim (2004) state
that foreign investors show a preference for value stocks. Here, we hypothesize the impact of
information in derivative markets on the stocks with high book to market value is stronger based
on the notion that smart traders want to earn cumulative excess returns through long-term
investment in value stocks.
H4. The impact of information in derivative markets on the stocks with more institutional
investors' holding would be stronger.
As stated earlier, both institutional and foreign investors may be smart traders who utilize
information in derivative markets since they are superior to individuals in obtaining and analyzing
information. If so, the impact of information in derivative markets on the stocks with higher
concentrations of institutions would be stronger.
H5. The impact of information in derivative markets on the non-lottery type stocks would be
stronger.
Kumar (2009) categorizes stocks into three types: lottery type, non-lottery type, and others and
investigates the respective investor groups' preferences to lottery type stocks. He reveals that
institutional investors concentrate their holdings in non-lottery type stocks. He specifically reports
lottery type stocks have low institutional holding (7.35%) whereas non-lottery type stocks have
high institutional holding (49.34%). Hence, the information in derivative markets might have a
stronger impact on the non-lottery type stocks which is heavily held by smart investors.

3. Methodology
3.1. Sample
We use FnDataGuide for monthly equity data and TS2000 database from Korea Listed
Companies Association for financial data. Data for monthly derivative index were obtained from
Korea Exchange, the Bank of Korea, and Korea Investors Service.
The sample spans the period from July 1987 through August 2010. We test in total 229
months excluding the Korean exchange crisis period during 1997 and 1998 in the sample. We

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include all listed, delisted, and newly listed companies in Korea Exchange for the period from
1987 through 2010 to circumvent both new listing bias and survival bias. Our sample in total
consists of 843 firms listed in the Korea Stock Exchange.

3.2. Derivative index

Prior works suggest transactions in derivative markets play an important role in predicting
future security price movements. A wide range of studies show that informed traders trade
securities on the transaction information such as VIX, PCR, PCO, changes in net futures, etc
(Bandopadhyaya and Jones, 2008; Banerjee, Doran, and Peterson, 2007; Dash and Moran, 2005;
Easley, O'Hara, and Srinivas, 1998; Giot, 2005; Kalok and Johnson, 1993; Kumar, Sarin, and
Shastri, 1998; Wang, Keswani, and Taylor, 2006; Whaley, 2000).
Vijh (1990) argues that specific option volumes contain information for future stock price
movements. Consistent with his findings, Easley, O'Hara, and Srinivas (1998) states option
volumes associated with "positive news" and "negative news" predict stock price movements.
Therefore, PCR which equals the trading volume of put options divided by the trading volume
of call options also indicates the future direction of stock price.
PCO, another measure of the putcall volume ratio, is calculated using the open interest of
options instead of trading volume. A high open interests of puts compared to calls indicates a
bearish market, and vice versa. PCO is considered as a more accurate indicator since it is
calculated using the open interest of options at the end of the day or at the end of the week.
Bhuyan and Yan (2002) also state that the open interest-based indicator is more informative
about the future movement of the underlying asset than the volume-based indicator.
If option markets are more attractive to informed traders, option trades would reflect
information which is not incorporated into spot market since option pricing models require the
price and volatility of underlying assets to determine the option price. Especially, implied
volatility derived from option prices convey information regarding short-term changes in
underlying asset prices to market participants.
VIX is an volatility index calculated using implied volatility of S&P100 (PEX) option at the
Chicago Board Options Exchange. Practitioners consider high implied volatility as a bull sign.
Implied volatility also reached all-time high during the financial crisis. Whaley (2000) also cites
VIX as "a barometer of investors' fear" based on his findings that the stock market reacts more
negatively to an increase in the VIX than it reacts positively to a decrease in the VIX.
The leverage implicit in futures makes futures market more attractive to informed traders
and futures market contains information which is not imparted to stock market yet (Sadath and
Kamaiah, 2009). Trading costs theory also suggests that futures market leads options market and
spot market as well (Fleming, Ostdiek, & Whaley, 1996).
The change in the net futures (the dollar-denominated volume of long contracts minus that
of short contracts) expresses investors' expectation toward market. Practitioners or media
frequently consider an increase in the volume of future contracts as a signal of investors
optimism about stock markets. Brown and Cliff(2004) also find out the change in net futures is
an important indicator capturing investors' sentiment.

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All the indicators mentioned above might include the components which are not related to
the direction of stock price. Hence, this study separates the common component using Principal
Component Analysis (PCA) and constructs a composite derivative index by following Baker and
Wurgler (2006)'s methodology.
We estimate the first principal component of the four proxies and their lags and then chose
four variables highly correlated with the first-stage index since the lead-lag relationship between
spot market and derivative markets is rather controversial. The composite index is the first
principal component of second-stage index using selected four variables. The resulted composite
derivative index, DINDEX, is as follows:

(1)

where PCRt is the put-call volume ratio at month t, PCOt is the put-call open interest ratio
at month t, VKOSPIt is the volatility index of KOSPI200 at month t, and FVOLt is the trading
volume of KOSPI200 stock index futures at month t.
The first principal component explains 43.01% of the sample variance, suggesting that it
captures the common variation moderately. Moreover, all indicators enter with the expected
timing as well as all enter with the expected sign. To be more specific, PCR, PCO, and
VKOSPI generated in the option market gauge investors' fear. The trading volume of KOSPI200
stock index futures also contain investors' pessimism about the stock market. Since investors in
the stock market tend to increase the short futures when investors expect the stock market
downside, increase in futures trading volume may represent investors' fear. All four variables
therefore are expected to have the same sign. The composite index tends to have high (low)
value when investors are pessimistic (optimistic) about the stock market. Based on these results,
we conclude that the composite index represents investors' sentiment in derivative markets.
Still, there is a possibility the composed index is contaminated by business cycle component.
We therefore form the second index orthogonal to business cycle component as follows: regress
each of the four raw indicators on growth in industrial production index, growth in consumer
durables, growth in consumer's expenditure, and a dummy variable for recession and residuals are
estimated. The residuals from these regressions, DINDEX, would capture pure information
directing future stock movements. The orthogonal index resulted from two-step PCA is

(2)

where PCRt is the put-call volume ratio orthogonal to business cycle at month t, PCOt is

the put-call open interest ratio orthogonal to business cycle at month t, VKOSPIt
volatility index of KOSPI200 orthogonal to business cycle at month t, and FVOLt

is the

is the trading

volume of KOSPI200 stock index futures orthogonal to business cycle at month t. Here, the first
principal component explains 44.20% of the sample variance of the orthogonalized variables.

- 5 -

3.3. Empirical Methods

Individual investors exhibit a preference for small firm, low-priced, high BM, low
institutional ownership, and lottery type stocks (Kumar and Lee, 2006; Kumar, 2009) and both
institutional and foreign investors express opposite preferences to individuals (Ko and Kim, 2004;
Kumar and Lee, 2006). To investigate the impact of information in derivative markets on the
Korean stock market, we construct 5-quintile portfolios sorted by market capitalization, book to
market ratio (BM), institutional ownership, and stock price and test the effect of the derivative
index

on

the

portfolio

returns.

We

further

compute

price,

idiosyncratic

skewness,

and

idiosyncratic volatility and form eight portfolios using price, skewness, and volatility break-points
adopting Kumar (2009)'s method to analyze the effect of information in derivative market on the
returns of lottery type stock.
We then estimate the following time-series factor model to test aforementioned hypotheses:

(3)

where, Rpt: Quintile portfolio return

Rft: Risk free rate of return
RMRFt: Excess market return at t month
SMBt: Monthly average return difference between three small size portfolios and
three big size portfolios
HMLt: Monthly average return difference between value portfolios and growth
portfolios
DINDEX: Derivative index at t month
DINDEX: Derivative index orthogonal to macro-economic variables at t month

4. Empirical Results
We attempts to investigate the effect of information in derivative markets on stock returns
based on the notion that smart traders trade on the information in derivative markets. More
specifically, we hypothesize the impact of information in derivative markets on stock returns is
stronger in the large-cap, high priced, value, high institutional owned, and non-lottery type stocks
since smart traders are inclined to avoid the stocks mostly traded by individual traders.

4.1. Size-quintile Portfolios

Table 1 shows the Fama-French 3-factor model estimates for each of the five-size quintile
portfolios. The composite derivative index has significantly negative effect on both medium and
large firm stocks. This negative effect suggests that stocks are underestimated when investors are
pessimistic about the stock market since such indicators considered in this study as PCR, PCO,
VKOSPI reflect investors' fear. The results for size-quintile portfolios also confirm the transaction
information in derivative markets have greater impact on both medium and large firm stocks,

- 6 -

which supports hypothesis 1.

4.2. Price-quintile Portfolios

The Fama-French 3-factor model estimates for price-sorted portfolios are presented in Table
2. Both DINDEX and DINDEX

have negative effect on all price portfolios suggesting that

stocks are underestimated when the smart traders have fear for stock market.
Both the coefficients and t-statistics decrease monotonically from the first quintile to the
fifth quintile portfolio. Especially, DINDEX and DINDEX

have significantly negative effect on

the third, forth, and fifth quintile portfolios. These results indicate that transaction information in
derivative market has greater impact on the high priced stocks which are mostly preferred by
smart traders.

4.3. BM-quintile Portfolios

Korean institutional investors' preference for growth stocks is not as strong as foreign
institutional investors' and foreign investors exhibit a preference for value stocks (Ko and Kim,
2004). However, we assumed that derivatives information has greater impact on value stocks
since smart traders want to earn cumulative excess returns through long-term investment in value
stocks.
Table 3 shows the results for BM-sorted portfolios. Whereas DINDEX have significantly
negative effect on the first, third, and fifth quintile portfolios, DINDEX

have significantly

negative effect on all portfolios. These results support Whaley (2000)'s findings that investors
require higher returns when they are pessimistic about the market since most of investors are
risk-averse.
Both DINDEX and DINDEX have the greatest impact on the fifth portfolio which is
consisted of stocks with high BM. These results are inconsistent with Kumar and Lee (2006)'s.
In their work, they show that the value stocks are one of retail investors' habitats and the effect
of investor sentiment is strongest on the price of value stocks. Considering the fact that
individuals and institutional investors exhibit roughly opposite preferences, one may argue that the
impact of the information in derivative markets on stock returns is stronger in the growth stocks.
However, there is a contradicting evidence that institutional investors exhibit a strong preference
for value stocks (Gompers and Metrick, 2001). Also, the mixed results could be originated from
the difference in average BM between Korean stocks and foreign stocks. The BM break-points in
this study are much higher than those presented in Kumar and Lee (2006)'s work. That is, there
could be difference in the definition of growth stock between Koreans and foreigners. Therefore,
the hypothesis that the information in derivative markets have a stronger effect on the value
stocks is appropriate and the empirical results support the hypothesis as well.

4.4. Institutional Ownership Portfolios

The results for institutional ownership portfolios are presented in Table 4. This study regards
both institutional and foreign investors as smart traders and hypothesizes the effect of information

- 7 -

in derivative markets is strongest on the stocks with high institutional ownership.

While the coefficients of derivative index for the fifth quintile portfolio (high institutional
ownership portfolio) are significantly negative at the level of 0.05, those for the remaining
quintile portfolios are negative but insignificant. These negative coefficients indicate stocks are
undervalued when investors' fear for market rises since derivative index largely reflect investors'
fear for market. The results for orthogonal derivative index are identical to those for derivative
index. These results attest to our assumption that institutional investors are smart traders is valid
and further support hypothesis 4 (the impact of information in derivative markets is strongest on
the stocks with high institutional ownership).

4.5. Lottery-type stock portfolios

The Fama-French 3-factor model estimates for lottery-type stock portfolios are given in
Table 5. We hypothesize informed trader prefer non-lottery type stocks contrary to individuals
and the impact of information formed in derivative markets is stronger on non-lottery type
stocks.
Derivative index has significantly negative effect on non-lottery type stocks, which supports
our hypothesis. It is also noteworthy that the effect of derivative index is stronger in the
portfolio with high volatility amongst the portfolios with high price. Also, the effect of derivative
index is strongest on stocks with both high skewness and high volatility. It implies that informed
traders seem to believe stocks with high return and volatility will reproduce high return and they
prefer the stocks with high return, volatility, and price.

- 8 -

Table 1. Fama-French 3-factor Model Estimates for Size Portfolios

This table reports Fama-French 3-factor model estimates for the five size-quintile portfolios. The quintile portfolios are
formed at the end of each year in December and then held constantly throughout the following year. We estimate the
following time-series factor model:

where, Rpt: Quintile portfolio return
Rft: Risk free rate of return
RMRFt: Excess market return at t month
SMBt: Monthly average return difference between three small size portfolios and three big size portfolios
HMLt:: Monthly average return difference between value portfolios and growth portfolios
DINDEX: Derivative index at t month

DINDEX : Derivative index orthogonal to macro-economic variables at t month

*, **, *** represent the significance at the level of 0.1, 0.05, and 0.01, respectively.

Panel A. DINDEX
0
Low
Q2
Q3
Q4
High

RMRF

SMB

HML

SENT

coef

-0.007)

1.005)

0.484)

0.097)

(-0.007***

t-stat

(-1.557)

(23.344)

(17.331)

(2.054)

(-1.636)***

coef

-0.012)

0.992)

0.366)

0.142)

(-0.008***

t-stat

(-2.617)

(22.122)

(12.612)

(2.890)

(-1.981**)*

coef

-0.017)

1.027)

0.285)

0.185)

(-0.010***

t-stat

(-3.787)

(24.005)

(10.277)

(3.954)

(-2.344***)

coef

-0.015)

1.042)

0.197)

0.143)

(-0.007***

t-stat

(-3.337)

(23.382)

(6.841)

(2.922)

(-1.731*)**

coef

-0.007)

1.023)

0.053)

0.049)

(-0.004***

t-stat

(-2.462)

(33.623)

(2.721)

(1.489)

(-1.340)***

HML

SENT

Adj. R2
0.84
0.80
0.82
0.81
0.89

Panel B. DINDEX
0
Low
Q2
Q3
Q4
High

RMRF

SMB

coef

-0.006)

1.002)

0.486)

0.096)

(-0.009***

t-stat

(-1.528)

(23.372)

(17.562)

(2.060)

(-2.149**)*

coef

-0.012)

0.988)

0.370)

0.141)

(-0.011***

t-stat

(-2.603)

(22.172)

(12.847)

(2.919)

(-2.527***)

coef

-0.016)

1.022)

0.288)

0.186)

(-0.012***

t-stat

(-3.798)

(24.067)

(10.509)

(4.019)

(-2.826***)

coef

-0.015)

1.038)

0.200)

0.142)

(-0.009***

t-stat

(-3.326)

(23.412)

(6.995)

(2.944)

(-2.231**)*

coef

-0.007)

1.019)

0.055)

0.046)

(-0.006***

t-stat

(-2.397)

(33.829)

(2.837)

(1.427)

(-2.257**)*

- 9 -

Adj. R2
0.84
0.81
0.82
0.81
0.90

Table 2. Fama-French 3-factor Model Estimates for Price Portfolios

This table reports Fama-French 3-factor model estimates for the five price-quintile portfolios. The quintile portfolios are
formed at the end of each year in December and then held constantly throughout the following year. We estimate the
following time-series factor model:

where, Rpt: Quintile portfolio return
Rft: Risk free rate of return
RMRFt: Excess market return at t month
SMBt: Monthly average return difference between three small size portfolios and three big size portfolios
HMLt:: Monthly average return difference between value portfolios and growth portfolios
DINDEX: Derivative index at t month

DINDEX : Derivative index orthogonal to macro-economic variables at t month

*, **, *** represent the significance at the level of 0.1, 0.05, and 0.01, respectively.

Panel A. DINDEX
0
Low
Q2
Q3
Q4
High

RMRF

SMB

HML

coef

-0.001)

0.987)

0.317)

0.050)

(-0.003***

t-stat

(-0.214)

(22.736)

(11.277)

(1.061)

(-0.878)***

coef

-0.011)

1.045)

0.292)

0.173)

(-0.003***

t-stat

(-2.495)

(23.944)

(10.328)

(3.629)

(-0.860)***

coef

-0.010)

1.064)

0.264)

0.139)

(-0.007***

t-stat

(-2.389)

(24.563)

(9.400)

(2.938)

(-1.654*)*

coef

-0.015)

0.999)

0.256)

0.127)

(-0.009***

t-stat

(-3.515)

(24.270)

(9.607)

(2.809)

(-2.292**)*

coef

-0.021)

0.994)

0.256)

0.125)

(-0.013***

t-stat

(-5.478)

(26.734)

(10.651)

(3.081)

(-3.667***)

Panel B. DINDEX
0
Low
Q2
Q3
Q4
High

SENT

0.80
0.82
0.82
0.82
0.85

RMRF

SMB

HML

SENT

coef

-0.000)

0.983)

0.319)

0.046)

(-0.007***

t-stat

(-0.116)

(22.772)

(11.438)

(0.977)

(-1.760*)**

coef

-0.011)

1.042)

0.293)

0.172)

(-0.005***

t-stat

(-2.467)

(23.912)

(10.421)

(3.629)

(-1.270)***

coef

-0.010)

1.060)

0.266)

0.138)

(-0.009***

t-stat

(-2.361)

(24.619)

(9.581)

(2.948)

(-2.242**)*

coef

-0.015)

0.996)

0.260)

0.127)

(-0.011***

t-stat

(-3.527)

(24.301)

(9.812)

(2.863)

(-2.690***)

coef

-0.021)

0.989)

0.261)

0.127)

(-0.015***

t-stat

(-5.548)

(26.914)

(11.013)

(3.192)

(-4.191***)

- 10 -

Adj. R2

Adj. R2
0.81
0.82
0.82
0.82
0.85

Table 3. Fama-French 3-factor Model Estimates for BM Portfolios

This table reports Fama-French 3-factor model estimates for the five BM-quintile portfolios. The quintile portfolios are
formed at the end of each year in December and then held constantly throughout the following year. We estimate the
following time-series factor model:

where, Rpt: Quintile portfolio return
Rft: Risk free rate of return
RMRFt: Excess market return at t month
SMBt: Monthly average return difference between three small size portfolios and three big size portfolios
HMLt:: Monthly average return difference between value portfolios and growth portfolios
DINDEX: Derivative index at t month

DINDEX : Derivative index orthogonal to macro-economic variables at t month

*, **, *** represent the significance at the level of 0.1, 0.05, and 0.01, respectively.

Panel A. DINDEX
0
Low
Q2
Q3
Q4
High

RMRF

SMB

coef

-0.015)

0.965)

0.156)

-0.085)

(-0.006***

(-4.083)

(26.045)

(6.492)

(-2.093)

(-1.718*)**

coef

-0.010)

1.003)

0.192)

0.030)

(-0.004***

t-stat

(-2.512)

(25.264)

(7.480)

(0.704)

(-1.182)***

coef

-0.011)

1.034)

0.283)

0.120)

(-0.008***

t-stat

(-2.679)

(25.478)

(10.785)

(2.694)

(-2.169**)*

coef

-0.012)

1.040)

0.323)

0.257)

(-0.005***

t-stat

(-2.690)

(23.805)

(11.428)

(5.359)

(-1.216)***

coef

-0.009)

1.047)

0.431)

0.293)

(-0.012***

t-stat

(-2.052)

(23.240)

(14.751)

(5.935)

(-2.802***)

Q2
Q3
Q4
High

SENT

t-stat

Panel B. DINDEX

Low

HML

RMRF

SMB

0.83
0.82
0.83
0.82
0.83

HML

SENT

coef

-0.015)

0.962)

0.158)

-0.086)

(-0.008***

t-stat

(-4.073)

(26.114)

(6.652)

(-2.148)

(-2.305**)*

coef

-0.010)

0.999)

0.194)

0.027)

(-0.007***

t-stat

(-2.453)

(25.339)

(7.627)

(0.637)

(-1.991**)*

coef

-0.011)

1.030)

0.287)

0.119)

(-0.011***

t-stat

(-2.669)

(25.571)

(11.024)

(2.727)

(-2.733***)

coef

-0.012)

1.037)

0.325)

0.255)

(-0.007***

t-stat

(-2.655)

(23.821)

(11.581)

(5.379)

(-1.790*)**

coef

-0.009)

1.043)

0.435)

0.295)

(-0.014***

t-stat

(-2.065)

(23.263)

(15.026)

(6.053)

(-3.147***)

- 11 -

Adj. R2

Adj. R2
0.84
0.83
0.84
0.82
0.83

Table 4. Fama-French 3-factor Model Estimates for Institutional Ownership Portfolios

This table reports Fama-French 3-factor model estimates for the five institutional ownership-quintile portfolios. The
quintile portfolios are formed at the end of each year in December and then held constantly throughout the following
year. We estimate the following time-series factor model:

where, Rpt: Quintile portfolio return
Rft: Risk free rate of return
RMRFt: Excess market return at t month
SMBt: Monthly average return difference between three small size portfolios and three big size portfolios
HMLt:: Monthly average return difference between value portfolios and growth portfolios
DINDEX: Derivative index at t month

DINDEX : Derivative index orthogonal to macro-economic variables at t month

*, **, *** represent the significance at the level of 0.1, 0.05, and 0.01, respectively.

Panel A. DINDEX
0
Low

Q2

Q3

Q4

High

RMRF

SMB

HML

SENT

coef

-0.012)

1.045)

0.095)

0.070)

(-0.014

t-stat

(-1.494)

(12.108)

(1.589)

(0.863)

(-0.833)

coef

-0.007)

1.031)

0.242)

0.248)

(-0.006

t-stat

(-0.893)

(11.576)

(3.922)

(2.970)

(-0.358)

coef

-0.005)

0.964)

0.241)

0.266)

(-0.001

t-stat

(-0.768)

(12.463)

(4.508)

(3.666)

(-0.067)

coef

-0.012)

1.384)

0.226)

0.187)

(0.001

t-stat

(-1.122)

(12.256)

(2.894)

(1.768)

(0.061)

coef

-0.020)

1.089)

0.113)

0.027)

(-0.029

t-stat

(-1.829)

(9.665)

(1.444)

(0.259)

(-1.289)

SENT

Adj. R

0.68

0.65

0.68

0.67

0.59

Panel B. DINDEX
0
Low

Q2

Q3

Q4

High

RMRF

SMB

HML

coef

-0.012)

1.051)

0.094)

0.074)

(-0.011*

t-stat

(-1.628)

(12.673)

(1.595)

(0.942)

(-1.011)*

coef

-0.008)

1.029)

0.239)

0.246)

(-0.007*

t-stat

(-1.113)

(12.026)

(3.908)

(3.033)

(-0.657)*

coef

-0.011)

0.941)

0.226)

0.248)

(-0.014*

t-stat

(-1.662)

(12.787)

(4.304)

(3.555)

(-1.396)*

coef

-0.013)

1.378)

0.223)

0.183)

(-0.001*

t-stat

(-1.343)

(12.690)

(2.880)

(1.776)

(-0.102)*

coef

-0.021)

1.093)

0.106)

0.030)

(-0.028*

t-stat

(-2.183)

(10.183)

(1.392)

(0.299)

(-1.867*)

- 12 -

Adj. R
0.69

0.65

0.68

0.67

0.60

Table 5. Fama-French 3-factor Model Estimates for Lottery Type Stock Portfolios
This table reports Fama-French 3-factor model estimates for the eight lottery type stock portfolios. In Table 5, the
respective letter P, S, and V denote price, idiosyncratic skewness, and idiosyncratic volatility. For instance, HP_LS_LV is
a portfolio consisted of stocks with high price, low idiosyncratic skewness, and low idiosyncratic volatility. We estimate
the following time-series factor model:

where, Rpt: Quintile portfolio return
Rft: Risk free rate of return
RMRFt: Excess market return at t month
SMBt: Monthly average return difference between three small size portfolios and three big size portfolios
HMLt:: Monthly average return difference between value portfolios and growth portfolios
DINDEX: Derivative index at t month

DINDEX : Derivative index orthogonal to macro-economic variables at t month

*, **, *** represent the significance at the level of 0.1, 0.05, and 0.01, respectively.

Non
lottery
type

HP_LS_LV
HP_LS_HV
HP_HS_LV
HP_HS_HV
LP_LS_LV
LP_LS_HV
LP_HS_LV

Lottery
type
Non

LP_HS_HV

HP_LS_LV

lottery
type

HP_LS_HV
HP_HS_LV
HP_HS_HV
LP_LS_LV
LP_LS_HV
LP_HS_LV

Lottery
type

LP_HS_HV

coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat

0
-0.007)
(-1.904)
-0.024)
(-4.622)
-0.009)
(-2.313)
-0.029)
(-5.435)
0.001)
(0.303)
-0.018)
(-3.346)
-0.002)
(-0.504)
-0.017)
(-2.980)

coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat
coef
t-stat

-0.007)
(-1.892)
-0.024)
(-4.672)
-0.009)
(-2.282)
-0.029)
(-5.492)
-0.001)
(-0.399)
0.002)
(0.442)
-0.018)
(-3.321)
-0.017)
(-3.004)

Panel A. DINDEX
RMRF
SMB
0.860)
0.157)
(21.736)
(6.119)
1.040)
0.347)
(20.298)
(10.444)
0.886)
0.116)
(23.260)
(4.706)
1.135)
0.309)
(21.817)
(9.189)
0.970)
0.247)
(22.912)
(9.030)
1.189)
0.546)
(22.881)
(16.210)
0.978)
0.200)
(23.435)
(7.420)
1.141)
0.411)
(20.389)
(11.324)

Panel B. DINDEX
0.857)
0.160)
(21.781)
(6.304)
1.034)
0.353)
(20.366)
(10.762)
0.882)
0.119)
(23.398)
(4.895)
1.131)
0.316)
(21.681)
(9.389)
0.974)
0.201)
(23.417)
(7.496)
0.966)
0.247)
(22.788)
(9.031)
1.186)
0.547)
(22.838)
(16.305)
1.139)
0.414)
(20.319)
(11.441)

- 13 -

HML
0.137)
(3.152)
0.019)
(0.354)
0.147)
(3.516)
0.127)
(2.236)
0.147)
(3.173)
0.094)
(1.649)
0.161)
(3.516)
0.177)
(2.881)

SENT
(-0.008***
(-2.236**)*
(-0.017***
(-3.408***)
(-0.008***
(-2.111**)*
(-0.019***
(-3.652***)
(-0.001***
(-0.423)***
(-0.003***
(-0.687)***
(-0.001
(-0.392)**
(-0.010**
(-1.777*)*

0.137)
(3.201)
0.022)
(0.411)
0.145)
(3.544)
0.134)
(2.370)
0.155)
(3.437)
0.139)
(3.026)
0.092)
(1.630)
0.180)
(2.949)

(-0.010***
(-2.727***)
(-0.019***
(-3.868***)
(-0.010***
(-2.869***)
(-0.018***
(-3.614***)
(-0.005***
(-1.282)
(-0.002***
(-0.615)***
(-0.005***
(-1.057)***
(-0.010***
(-1.828*)**

Adj. R2
0.78
0.77
0.81
0.79
0.80
0.83
0.80
0.78

0.79
0.78
0.81
0.79
0.81
0.80
0.83
0.78

5. Concluding Remarks
This paper investigate the impact of transaction information in derivative markets on the
Korean stock market. The fundamental assumption of this study are 1) both institutional and
foreign investors are smart traders who trade securities on transaction information in derivative
markets and 2) smart traders tend to concentrate their holdings in large, high priced, high BM,
high institutional ownership, and non-lottery type stocks. To test our hypothesis that the impact
of transaction information in derivative markets is stronger on the stocks preferred by smart
traders, we first construct a composite derivative index using principal component of four
derivative indicators following Baker andWurgler (2006)'s methodology. Then, we build several
portfolios sorted on firm size, price, book to market value, institutional ownership, and lottery
type features as Kumar and Lee (2006) and Kumar (2009) did and examine the impact of
transaction information in derivative markets on the respective portfolios returns with the
composed derivative index.
The major findings of this research is as follows: 1) the transaction information in derivative
market has the greater impact on stocks preferred by smart traders (i.e., large firm, high priced,
high BM, high institutional ownership, and non-lottery type stocks and 2) the transaction
information in derivative market has a negative effect on stock returns. It implies that stocks are
underestimated when investors are pessimistic about the stock market since such indicators
considered in this study as PCR, PCO, VKOSPI reflect investors' fear.
This study contributes to literature review in that 1) it examines the effect of the transaction
information in derivative markets on spot market, 2) it proposed the additional evidence that
institutional

investors

exhibit

opposite

preferences

to

individuals,

and

3)

the

transaction

information in derivative markets is more informative to stocks with higher concentration of

smart traders.

- 14 -

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