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The effect of risk-taking behavior on profitability: Evidence from futures market

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  • Cheng, Teng Yuan
  • Lee, Chun I.
  • Lin, Chao Hsien

Abstract

We explore how futures traders make a tradeoff between risk and return by examining their risk-taking in the action. By applying a novel measure to their trade-by-trade transactions to capture their tendency in risk-taking, we find a general tendency to reduce risk-taking by cutting positions when facing losses or gains, and the tendency is stronger in the case of losses. However, great variations exist among traders in the risk-taking tendency and the results for trading are opposite for profitable and unprofitable traders. For the unprofitable, more risk-taking by trading more actively leads to greater losses. This is concrete evidence for the prevailing belief in the literature that trading too much, arguably due to overconfidence, is hazardous to investor's wealth. Contrary to that belief, however, we find fresh evidence that more active trading by the profitable traders leads to greater profits, suggesting their trades are likely based on ability and skills.

Suggested Citation

  • Cheng, Teng Yuan & Lee, Chun I. & Lin, Chao Hsien, 2020. "The effect of risk-taking behavior on profitability: Evidence from futures market," Economic Modelling, Elsevier, vol. 86(C), pages 19-38.
    • Handle: RePEc:eee:ecmode:v:86:y:2020:i:c:p:19-38
    DOI: 10.1016/j.econmod.2019.04.017
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    More about this item

    Keywords

    Risk-taking; Profitability; Individual trader; Reversals of loss; Overconfidence;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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