Shaken markets : how earthquakes rattle investors?

Abstract

We use account-level derivatives transaction data to examine the trading behavior and profitability on earthquake days. Our research shows that, although both institutional and retail investors reduce their options trading on earthquake days, retail investors, unlike their institutional counterparts, display heightened risk perception and take more net bearish directional bets in response to such shocks. Retail investors also demonstrate enhanced cross-hedging behavior in futures and options market on earthquake days rather than institutional investors. Further analysis reveals that institutional investors experience lower returns on earthquake days compared to non-earthquake days, whereas retail investors tend to incur smaller losses during these events. This divergence is attributable to the significantly reduced number of unsophisticated retail investors trading as the counterpart for institutional investors. These findings suggest that earthquakes disproportionately create greater entry barriers for unsophisticated retail investors from entering the market, contributing to the decreased profitability of institutional investors.