1

FEAR, GREED, AND TRADING ACTIVITIES

Chin-Shui Lo, Department of Finance, Chang Jung Christian University, Taiwan (R.O.C.) ,
No.396, Sec. 1, Changrong Rd., Gueiren Dist., Tainan City 71101, Taiwan (R.O.C.),
locs@mail.cjcu.edu.tw, Tel: 886-6- 2785-123
ABSTRACT
This study uses the VIX debuted in 1993 to construct fear and greed indices for financial
markets and to examine the effects of fear and greed on trading activities in Taiwan. We find
that fear is negatively associated with and that greed is positively associated with trading
activities. In high trading activity quantiles, greed exerts more influence than fear. In contrast,
empirical results suggest that fear dominates greed in low trading activity quantiles. Finally,
greed has a greater influence than fear on stocks with low prices, low market capitalization,
high returns, and high turnover.
Keywords: Fear, Greed, Implied volatility
1. INTRODUCTION
Financial crises have recently burst out everywhere, and their effects often last for several
years. Many observers attribute these crises to the decisive role played by greed ([21]). The
Internet boom of 2000 is a perfect example of greed. During the greed-caused financial crisis
of 2008 ([23]), financial assets experienced significant drops, the correlation between asset
classes increased significantly, and the fear index (VIX) reached its highest level in October
2008 ([16]). Numerous academics and market participants are extensively concerned with
fear and greed, which coexist in the market and have mutual implications. Both forces
contribute immensely to market volatility. The VIX method, which functions as a barometer
of risk for financial assets, is a weighted index that comprises the implied volatility of put and
call options. This study uses the VIX method to compute the implied volatility of put and call,
which respectively serve as proxies for fear and greed. We use the aggregate trading
activities-trading value, trading shares, and turnover as proxies for investors trading activity.
If investors are concerned about fear and greed, the differential effects of fear and greed
should be apparent in their trading activities.
The Chicago Board Options Exchange (CBOE) originally constructed an implied volatility
index (VIX), based on eight near-the-money, nearby, and second-nearby call and put options
of the S&P 100 index. This CBOE index is said to be the investors fear gauge, where the
term fear is used because investors are risk averse and fearful of uncertainty. When
investors suffer large losses, they become more fearful of further losses. To stem their losses,
investors quickly sell portfolios in search of less risky assets such as money market securities
and principal-protected funds, which are low-risk, low-return securities. When traders fear
losses, they start selling stocks. These sales drag down stock prices heavily, causing financial
markets to crash irrationally.
The financial market is driven by two prominent emotions: fear and greed. The interplay of
2
fear and greed often appears in financial markets. Financial markets generally move upward,
but downturn periods cause investors to retreat. Fear is temporary, yet greed is permanent.
Greed takes over when investors see others making money and want to game before
opportunities fade. When people approach the stock market with greed, stock prices start
rising sharply because of heavy purchasing based on speculations about a possible uptrend of
prices.
[15] argued that the VIX method is the best aggregate fear gauge for sophisticated and
well-informed investors in the nearby index option market. However, he also showed that
implied volatility has weak power in predicting future returns. [3] showed that when both
individual and institutional sentiments decrease and the fear gauge increases, investors reduce
their net purchasing volume and market liquidity. [6] applied a survey sentiment [Financial
and Economic Attitudes by Research survey (FEARS)] to show that FEARS triggers excess
volatility and daily mutual flow. Their evidence suggests that one standard deviation increase
in FEARS is associated with approximately 40% outflow of the daily average mutual fund.
Investors differ greatly in their characteristics. Some investors are more optimistic about a
potential rise in the stock market in the future, and purchase more call options. Conversely,
some investors are more pessimistic about a potential drop in the stock market, and therefore,
purchase more put options to hedge their positions. The VIX method is a weighted measure
of the implied volatility of four put and four call options on the S&P 100. Therefore, VIX is a
measure of perceived market volatility in either direction over the next 30 days, including the
upside and downside. A high VIX index suggests that investors see significant risk that the
market will move sharply, whether downward or upward. [15] suggested that increases in the
VIX index are associated with option prices. When a large shock that affects the market leads
to a greater change in the magnitude of one type of option relative to the others, the VIX
moves along the direction of the net change. If a positive shock causes investors to believe
that the market is moving upward, the result could raise the price of call options and reduce
the price of put options. When the magnitude of changes in call options exceeds that of put
options, the net differential effects of these two options increases the VIX index. Conversely,
a negative shock increases the price of put options and reduces the price of call options. If the
magnitude of a price increase of put options exceeds the decrease in the price of call options,
the VIX rises.
The VIX index represents both the fear and exuberance of sophisticated and informed
investors. A high VIX index suggests that the market will move either upward or downward.
In this case, it is appropriate to partition the VIX into implied volatility of put, a proxy of fear,
and implied volatility of call, a proxy of greed. We partition VIX into perceived volatility of
put and call to investigate whether fear and greed are related to the trading activities of
investors.
This study uses the VIX method proposed in 1993 to compute the fear and greed index and
examine their effects on trading activities. Results show that fear and greed are negatively
and positively associated, respectively, with trading activities. However, greed also exerts a
greater influence than fear during high trading activities. Conversely, fear dominates greed
during low trading activities. We also show that greed has a greater influence than fear on
stocks with low prices, low market capitalization, high returns, and high turnover.
3
The remainder of this paper is structured as follows. Section 2 introduces the literature review
and hypothesis development. Section 3 presents the data and empirical model. Section 4
provides the empirical results, and Section 5 offers a conclusion.
2. LITERATURE REVIEW AND HYPOTHESIS
[18] showed that fear and greed both trigger investors trading behaviors in financial markets.
Although fear plays an essential role in financial markets, most investors react less to greed.
Fear and greed are polar opposites, with fear being a negative emotion and greed being a
positive emotion. Fear drives investors to bid up put prices and reduce or hedge risk. Greed
causes investors to look for ways to profit from the trading activity itself and bid up call
prices. The perceptions of option traders are the dominant factors in determining the VIX
([11]). We use the implied volatility of a put option as a proxy for fear, and use the implied
volatility of a call option to represent greed. If investors are optimistic about the spot market,
they purchase securities, which in turn drive prices up and increase trading activity. The call
option value increases when implied volatility increases after entering the long call.
Conversely, if investors are pessimistic about the spot market, they either reduce the trading
activities in the spot market or they long a put option in the futures market. If investors enter
a put option, this results in an increase in the implied volatility of the put option, along with
its value. We postulate that fear and greed influence trader behaviors such that the fear of
additional loss decreases trading activities and the greed for potential profit promotes the
trading activities. We present the first hypothesis as follows:
H1
0
: Fear (greed) has a negative (positive) effect on trading activity in the spot market.
[11] provided evidence confirming that the return-implied volatility relationship is strongly
associated with extreme returns. Investors in financial markets swing between the extremes
of fear and greed. If fear and greed affect each other in the financial market, we should be
able to find the relative effects of fear and greed on differential trading activities. When greed
is greater than fear, investors purchase aggressively, increasing the aggregate trading activity.
Specifically, greed dominates fear during a high trading activity. Conversely, when fear is
greater than greed, investors are loath to trade and retreat from the market, decreasing the
trading activity; that is, fear dominates greed during low trading activity. Thus, we present
the second hypothesis as follows:
H2
0
: The effect of greed (fear) is relatively greater than that of fear (greed) during high (low)
trading activity.
[9] showed that the relationship between stock returns and implied volatility is asymmetric
because negative stock index returns produce greater changes in VIX than do positive returns.
Fear and greed are both sentiments, and whether they exert asymmetric effects on the trading
activity of low and high portfolios within certain stock characteristics remains unclear. [12]
suggested that stocks with low prices, high idiosyncratic skewness, and greater idiosyncratic
volatility are more likely to be perceived as lotteries. [8] showed that when the jackpot
exceeds NT$500 million, the number of shares traded by individual investors significantly
decreases among stocks with low market capitalization, high past returns, and a high past
turnover. This indicates that lottery tickets function as a substitute investment to stocks with
low market capitalization, high past returns, and a high past turnover. Greed is an important
4
reason for purchasing lottery tickets and gambling. We presume that trading activities among
stocks with a low stock price, low market capitalization, high return, and high turnover are
more likely to be affected by greed than by fear. Among stocks with a high price, high market
capitalization, low return, and low turnover, investors move their money from the stock
market to low-risk and low-return securities to stem their losses during a financial crisis.
Thus, we present the third hypothesis as follows:
H3
0
: The effect of greed on trading activities is greater (smaller) than that of fear within a low
(high) stock price, low market capitalization, high return, and high turnover portfolios.
3. DATA AND METHODOLOGY
3.1 Construction of the fear and greed index
Implied volatility (VIX), which is a measure of the fear of uncertainty, is also a measure of
investor sentiments. This index was originally introduced in 1993 and computed from the
implied volatility of eight put and call option series near-the-money, nearby, and
second-nearby option series, and was weighted to reflect the implied volatility of a 30
calendar-day at-the-money option. We partitioned the VIX into implied volatility of the put
and volatility of call options. Our weighted implied volatility of the put (call) option was
computed by referring to the CBOE construction.
The greed index was computed based on a series of implied volatility for call options, and
referred to the construction of fear index. Thus, this study uses separate fear and greed
indices. Fear and greed are the two driving forces in financial markets. Greed drives up prices
and has many traders follow suit and purchase the securities. Greed also drives up prices to a
level where they are no longer sustainable, forming a bubble. In times of bull market rallies,
greed captures traders completely and eclipses fear. As traders watch the stock market move
strongly upward, they might be persuaded to purchase a call option even if they do not have
such trading experience. Conversely, fear increases traders pessimistic expectations for
short-term returns about underlying assets in the spot market, leading to a decrease in the
trading volume of underlying assets and an increase in the demand for a put option to hedge
long positions. Put and call options, such as greed and fear, work in tandem and complement
each other perfectly.
3.2 Trading activities of subgroups with certain characteristic
Financial markets are simultaneously driven by the emotions of optimistic and pessimistic
investors. Investors are not homogenous with respect to fear and greed, and we presume that
some stocks associated with certain characteristic response to fear/greed are more stronger
than the other. For example, Shleifer and Thaler (1991) showed that returns with small
market capitalization and lower institutional holdings are corrected with changes in
closed-end fund discounts. This study investigates the relationship between fear and greed
and the trading activities of stocks with certain characteristics. To build on this theme, we
constructed three subgroups of stocks with certain stock characteristics, and tested how the
trading activities influenced by fear and greed. The trading activities of stocks with certain
characteristics are classified equally into three subgroups based on their characteristics at the
end of the previous season. We then averaged the trading activities across all stocks in each
of the three subgroups.
5
The implied volatility of a put option implies uncertainty and fear for the future. Thus, the
sign of the coefficient for fear (implied volatility of put) in the following regression model
should be negative. The buyer of a call option purchases it in the hope that the price of the
underlying instrument will rise in the future. A high implied volatility of a call option is an
indicator that mirrors the optimism about underlying assets in the future. Thus, the sign of
coefficients for greed (implied volatility of call) should be positive. To examine the effects of
fear and greed on trading activities in low, medium, and high group with certain characteristic,
this study presents the following empirical systemic regressions based on the works by [8]
and [19]:
t l t c l t p l t l l l t l
control VIX VIX TV TV
, , 3 , , 2 , 1 , 1 , 0 , ,


t m t c m t p m t m m m t m
control VIX VIX TV TV
, , 3 , , 2 , 1 , 1 , 0 , ,


t h t c h t p h t h h h t h
control VIX VIX TV TV
, , 3 , , 2 , 1 , 1 , 0 , ,


where TV
l,t
, TV
m,t
, and TV
h,t
are the trading activities for all stocks with a certain
characteristic in a portfolio in the low, medium, and high group, respectively. We added the
lagged term of the dependent variable to control the endogeneity and the persistence in the
trading activities. The term VIX
p
(VIX
c
) denotes the fear (greed) index. The systemic
regressions in this study augment a set of control variables, including lagged market returns,
term spread ([14] [1] [22]), and dummies for weekdays ([7] [4]). Term spread is the
difference between the yield on a 10-year treasury bond and 90-day commercial paper rate.
All variables examined in this paper were obtained from the Taiwan Economic Journal (TEJ).
To compare the effects of fear and greed on trading activities within a subgroup of stocks, we
estimated three regression equations simultaneously. Because the error terms are assumed to
be correlated across the equations, we performed seemingly unrelated regression (SUR) to
examine the effects of fear and greed on the trading activities of high and low subgroups with
certain characteristic.
[13] showed that sentiment affects the trading behavior of small-cap return, particularly
among stocks with lower stock prices, low institutional ownership, and higher B/M ratios,
especially if these stocks are also costly to arbitrate. [5] used implied volatility as an indicator
of timing strategies, showing that changes in the VIX are associated with future return
differences between value versus growth and large cap versus small cap portfolios. However,
this study focuses on the relationship between fear and greed and the trading activities of
investors without investigating sentiment-return relationships. This study classifies the
trading activities of all stocks into three subgroups based on the value stock prices, market
capitalization, turnover, and stock returns at the end of the last season.
4. EMPIRICAL RESULTS
4.1 Descriptive statistics
The options of the Taiwan Stock Exchange Capitalization Weighted Stock Index (TAIEX)
debuted on January 2, 2002. To ward off the effects of low trading activity of options on the
fear and greed indices, we dropped data for the first 2 years after this debut. The sample
period spans from January 2, 2004 to June 29, 2012, and includes 2111 daily observations.
The implied volatility provides additional information as the trading volume increases. Panel
A in Table 1 presents descriptive statistics for the daily variables of market returns, term
6
spread, fear, greed, and three trading activities: trading value, trading shares, and turnover.
The mean daily trading value amounts to NT$106 billion. On average, 4.09 billion shares
were traded each day for a yield daily turnover of 0.595. Fear and greed are proxied by the
implied volatility of the put and call options respectively, and the fear index is greater and
more volatile than that of greed. The maximum (minimum) market returns approximated to
daily price limits of 7% set by the Taiwan Stock Exchange Corporation. The Pearson
correlation coefficients in Panel B of Table 1 suggest that the fear index is significantly
negative to aggregate trading value and market returns, and not significantly associated with
aggregate trading shares and turnover. Consistent with previous research ([9]), the Pearson
correlation coefficients in this study support a contemporary negative relationship between
the fear index and the returns of underlying assets. The greed index is positively related to
trading value, shares, turnover, and market returns. According to the Pearson correlation
coefficients, fear and greed both have a positive relationship.
Tabel 1 Descriptive statistics
Panel A of Table 1 presents descriptive statistics for the daily variables of market returns
(M-return), term spread (TS), fear (VIX
p
), greed (VIX
c
), and three trading activities: trading
value (value), trading shares (volume), and turnover (turnover). The term spread is the
difference between the yield on a 10-year treasury bond and the 90-day commercial paper
rate. Pearson correlation coefficients are reported in Panel B. * denotes significance at the
level of 5%.
Panel A
Variable Value Volume Turnover VIX
p
VIX
c
Mreturn TS
Mean 106000000 4096654 0.5946 0.2586 0.2104 0.0101 0.5046
Std. 38800000 1381560 0.2563 0.1145 0.0831 1.3856 0.4985
Min 23800000 1396733 0.1890 0.1090 0.0504 -6.9123 -0.7991
Max 322000000 11600000 2.2312 1.3159 0.7890 6.5246 1.9684
Panel B
volume 0.9176* 1.0000
0.0000
turnover 0.7628* 0.9139* 1.0000
0.0000 0.0000
VIX
p
-0.0997* 0.0048 -0.0156 1.0000
0.0000 0.8253 0.4747
VIX
c
0.1143* 0.2526* 0.2453* 0.7198* 1.0000
0.0000 0.0000 0.0000 0.0000
Mreturn 0.0818* 0.0785* 0.0916* -0.1926* -0.0091 1.0000
0.0002 0.0003 0.0000 0.0000 0.6770
TS -0.0743* 0.0552* 0.3317* -0.1469* -0.0635* 0.0331 1.0000
0.0006 0.0112 0.0000 0.0000 0.0035 0.1290
We standardized the fear index and trading activity to identify their mutual interaction on the
same figure. Figure 1 shows the standardized daily levels of the fear index and the aggregate
trading value of all stocks listed on the Taiwan Stock Exchange Corporation from January 2,
2004 to June 29, 2012. The most interesting phenomenon in the graph is the considerable
variation in the fear gauge since September 2007. This value jumps to its highest level on
7
October 27, 2008, during a global financial crisis. On the same day, the implied volatility for
Taiwan index options (TVIX) reaches its highest level of 83.54. The trading value of the
Taiwanese stock market fell to its lowest level in October 2008. Following the global
financial crisis of 2008, the Euro financial crisis emerged in 2010, striking fear in investors
again. Unlike the fear index, which fluctuates over time, the standardized trading values
hover between -2 and 6, equaling NT$23.8 to NT$322 billion.
Figure 1: Daily level of VIX gauge and aggregate trading shares
Figure 2 shows the standardized daily levels of the greed index in addition to the aggregate
trading value. There has been a magnificent variation in the greed index since 2007, and it
peaked to its highest level on May 4, 2009. Figures 1 and 2 show that fear and greed exhibit
similar patterns, whereas Panel B in Table 1 shows that both have a Pearson correlation
coefficient of 0.7198. This interplay between fear and greed seems like the motto of Warren
Buffett: We simply attempt to be fearful when others are greedy and to be greedy only when
others are fearful.
Figure 2: Daily level of VIX gauge and aggregate trading shares
We standardized the fear index and aggregate trading value to identify their mutual
implication on the same figure. Figure 1 shows the standardized daily levels of the fear
index and the aggregate trading value of all stocks listed by the Taiwan Stock Exchange
Corporation from January 2, 2004 to June 29, 2012. Figure 2 shows the standardized daily
levels of the greed index, in addition to the aggregate trading value.
8
4.2 Effects of fear and greed index on aggregate trading activities
Fear and greed are intriguing psychological concepts in financial markets. Greed causes
traders to purchase stocks in the expectation that the stock price will rise in the future. Fear
causes traders to sell stocks or paralyzes them into inactivity. To obtain an overall grasp of
the effects of fear and greed index on aggregate trading activities, we first regressed
aggregate trading value, a proxy of investors trading activities, on fear and greed gauges and
control variables. For simplicity, we dropped the results for the dummy variables of weekday.
The results presented in Table 2 show that the coefficient of the fear gauge is negative and
significantly different from zero, implying that fear threatens the trading activity of investors.
Conversely, the coefficient of greed is positive and significantly different from zero. A
comparison of these two coefficients shows that the magnitude of the greed effect is greater
than that of fear in the trading activities of investors. [3] showed that bearish and fear (VIX)
sentiments induce more sell orders and reduce market liquidity. When partitioning VIX into
fear and greed, we observed that the effect of greed on trading activities is much stronger
than that of fear. Although stock markets move up over time, there are short periods of fear
and doubt that cause investors to retreat. Fear may be a strong emotion, but the greed for
potential gain is much greater.
Table 2 Effects of fear and greed index on aggregate trading activity
This table shows the results of OLS of trading activities on fear, greed, and control variables.
t l t c l t p l t l l l t l
control VIX VIX TV TV
, , 3 , , 2 , 1 , 1 , 0 , ,


. The term TV is the aggregate
trading activity for all stocks. The term TV
t-1
is the lagged term of the dependent variable
(D.var(-1)), and VIX
p
(VIX
c
) denotes the fear (greed) index. Other control variables include
lagged market returns (Mretrun(-1)), lagged term spread (TS(-1)), and weekday dummy. The
term spread is the difference between the yield on a 10-year treasury bond and the 90-day
commercial paper rate. The last row presents the Wald-test results for fear and greed. ***, **,
and * denote the level of significance at 1%, 5%, and 10%, respectively.
Value Volume Turnover
Constant 3.195
***
2.887
***
0.052
***
14.607 15.428 4.912
D.var(-1) 0.827
***
0.807
***
0.829
***
70.191 65.186 71.179
VIXp -0.343
***
-0.256
***
-0.169
***
-6.319 -5.311 -4.912
VIXc 0.429
***
0.470
***
0.343
***
5.893 6.999 7.069
Mreturn(-1) 0.009
***
0.011
***
0.010
***
2.939 3.914 5.439
TS(-1) -0.023
***
-0.006 0.024
***
-2.689 -0.837 4.235
fear=greed 42.339 45.430 43.763
Again, we used the aggregate turnover as a proxy of investors trading activity, and the
results hold. Finally, instead of aggregate turnover with aggregate trading shares, this study
shows that greed is stronger than fear in its effects on the trading activities of investors. We
partitioned VIX into the implied volatility of put and call options, representing fear and greed,
respectively, to observe their effects on trading activities. The results of this study partially
9
support the effects of the interplay between fear and greed on the trading behaviors of
investors. Finally, regression analysis suggests that fear is negatively and significantly
associated with trading activity and that greed is positively and significantly associated with
trading activity for all three trading activities. Fear is the opposite of greed. These results
support H1
0
: Fear (greed) has a negative (positive) effect on trading activity in the spot
market. To obtain the subtle and distinctive effects of the fear and greed indices on the
trading activity of investors, we further examined whether fear and greed have differential
effects on the trading activity of stocks with certain characteristics.
4.3 How do fear and greed influence the trading activity of stocks with certain
characteristics?
Fear accompanied with greed, but they may have different influences on investors behaviors
because investors are not homogenous and are preferred to stocks with some characteristic.
For example, retail investors exhibit a preference for value stocks and small stocks ([2]),
whereas institutional investors tend to prefer large stocks with more liquidity ([10]). [8]
showed that on large jackpot drawing days, the number of shares traded by individual
investors significantly decreases among stocks with low market capitalization, high past
returns, and a high past turnover. Greed is the primary motivator for purchasing lottery tickets
and gambling. When investors trade in the stock market with greed, those stocks among low
stock price, low market capitalization, high return, and high turnover start rising because of
heavy purchasing based on speculation about a possible uptrend of prices.
We extracted the variables of characteristics for stocks from the TEJ database, and then
equally sorted all stocks into three subgroups based on the value of each characteristic at the
end of last season, forming low, medium, and high portfolios. After sorting, we averaged all
daily trading activities of the stocks in each portfolio to establish a time series of trading
activities for each subgroup. Fear and greed might have different influences on the trading
activity of each portfolio characterized by market capitalization, stock price, turnover, and
returns. To address these concerns, we conducted SUR to examine the differential magnitude
of the effects of fear and greed on the trading activities of low, medium, and high subgroups.
4.3.1 Stock subgroups sorted by market capitalization
For brevity, we dropped the empirical results for the weekday dummy variables, and used the
trading values to represent trading activity. Table 3 presents the SUR results. We sorted the
market capitalization of stocks, based on the value at the end of the previous season, into
three subgroups, and regressed their trading values on independent variables. The results
show that greed (fear) has a positive (negative) effect on the trading values among three low,
median, and high subgroups. For those stocks with low market capitalization, the coefficient
of greed is greater than that of fear on the trading value. This implies that the effects of greed
are stronger than the effects of fear. If people prefer stocks with low capitalization ([13]) and
lottery tickets ([8]), the trading activities of low capitalization are likely driven by greed.
Conversely, the effect of fear is greater than that of greed for high market capitalization.
Stocks with large market capitalizations are always traded by institutions that tend to trade by
discipline and have stop loss limits. Thus, trading activities with large market capitalization
are more likely affected by fear than greed.
4.3.2 Stock subgroups sorted by stock Price
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Table 3 shows the same picture when stock subgroups are sorted by stock price based on the
value at the end of the last season. In the low-priced stocks, the coefficient of greed is greater
than that of fear, implying that their trading activities are driven by fear more than by greed.
This result is similar to that by [8]. For stocks with a past high stock price, the fear index has
a greater influence on trading values than on greed. Investors of high stock prices are fearful
of potential losses because the losses for stocks with high prices are greater than those for
stocks with low prices. Thus, their trading activities are more vulnerable to fear than to greed.
Table 3 Effects of fear gauge on trading volume classified by stock characteristics
This table presents the results of seemingly unrelated regression (SUR) for trading activities
on fear, greed, and control variables.
t l t c l t p l t l l l t l
control VIX VIX TV TV
, , 3 , , 2 , 1 , 1 , 0 , ,


. TV
t
is the aggregate trading
activity all stocks. The term TV
t-1
is the lagged term of the dependent variable (D.var(-1)),
and VIX
p
(VIX
c
) denotes the fear (greed) index. Other control variables include lagged
market returns (Mretrun(-1)), term spread (TS(-1)), and weekday dummy. The term spread is
the difference between the yield on a 10-year treasury bond and the 90-day commercial paper
rate. The last row presents the Wald-test results for fear and greed. ***, **, and * denote the
level of significance at 1%, 5%, and 10%, respectively.
Stock price Market Stock return Turnover
Low group
Constant 2.695
***
0.326
***
0.334
***
0.096
(25.659) (3.924) (8.620) (1.296)
D.var(-1) 0.755
***
0.936
***
0.964
***
0.879
***
(69.888) (110.399) (256.787) (116.845)
VIXp -0.456
***
-0.733
***
-0.216
***
-1.03
***
(-4.001) (-7.678) (-3.549) (-12.010)
VIXc 1.022
***
1.851
***
0.199
***
0.629
***
(6.719) (14.495) (2.429) (5.482)
Mreturn(-1) 0.02
***
0.017
***
0.003) 0.01
***
(3.150) (3.222) (0.783) (2.121)
TS(-1) 0.125
***
0.249
***
-0.010 0.274
***
(6.998) (16.609) (-1.074) (20.328)
Adj R2 0.696 0.837 0.924 0.861
Medium group
Constant 0.746
***
0.994
***
0.451
***
1.492
***
(13.683) (16.727) (10.153) (23.257)
D.var(-1) 0.924
***
0.902
***
0.955
***
0.855
***
(178.669) (161.914) (241.851) (142.660)
VIXp -0.312
***
-0.37
***
-0.269
***
-0.51
***
(-4.816) (-5.794) (-4.173) (-7.843)
VIXc 0.318
***
0.306
***
0.289
***
0.398
***
(3.663) (3.589) (3.345) (4.613)
Mreturn(-1) 0.007** 0.009
***
0.007* 0.01
***
(1.999) (2.407) (1.852) (2.872)
TS(-1) -0.001 0.002 -0.004 -0.008
(-0.121) (0.185) (-0.438) (-0.773)
Adj R2 0.887 0.880 0.892 0.881
11
High group
Constant 0.861
***
1.412
***
0.695
***
2.303
***
(14.255) (17.225) (11.068) (23.038)
D.var(-1) 0.919
***
0.873
***
0.935
***
0.802
***
(169.522) (121.347) (169.025) (95.612)
VIXp -0.364
***
-0.392
***
-0.287
***
-0.44
***
(-5.668) (-6.668) (-4.515) (-7.063)
VIXc 0.301
***
0.306
***
0.369
***
0.591
***
(3.535) (3.947) (4.305) (7.011)
Mreturn(-1) 0.004 0.003 0.01
***
0.008
***
(1.110) (0.853) (2.851) (2.238)
TS(-1) -0.004 -0.02
***
0.001 -0.013
(-0.442) (-2.147) (0.055) (-1.346)
Adj R2 0.885 0.815 0.825 0.772
4.3.3 Stock subgroups sorted by stock return
Stocks within the high group are those stocks with returns that at the end of the previous
season fall in the top one-third percentile. As Table 3 shows, for those stocks among the past
high returns category, greed has a greater influence on their trading values than does fear. [8]
showed that lottery tickets are a substitute for high return stocks for people. In contrast, for
stocks with a low past return, the coefficient of fear is greater than that of greed. When all
stocks are sorted into three subgroups based on past stock return, fear and greed have
differential effects on the trading value among high and low stock return portfolios.
4.3.4 Stocks sorted by stocks turnover
The SUR results shown in Table 3 indicate that the trading values of stocks in the high
turnover portfolio increase as greed rises and decrease when fear rises. The trading value of
stocks with a high turnover reacts more positively to greed than it reacts negatively to fear. In
the low stock turnover group, trading values tend to be influenced more by fear than by
greed.
In summary, these results suggest that trading activities react to fear and greed
asymmetrically. Among the subgroup with low market capitalization, low stocks price, high
stock returns, and high turnover, trading values react more positively to an increase in greed
than they react negatively to an increase in fear. Greed is the primary motive in purchasing
lottery tickets at the cost of a small loss. These results are consistent to a degree with the
findings by [8], who showed that on the large jackpot drawing days, the number of shares
traded by individual investors significantly decreases among stocks with low market
capitalization, high past returns, and high past turnover. In contrast, fear has a more powerful
effect than greed among stocks with high market capitalization, high stocks price, low stock
returns, and low turnover. Perhaps the potential losses of wealth for these stocks are more
important to investors; therefore, their trading activities are more influenced by fear than by
greed. Thus, the SUR results support H3
0
.
4.4 Asymmetric effects of fear and greed on differential trading activity
These results confirm the differential effects of fear and greed on the trading values of stock
portfolios with certain characteristics. [24] showed that the relationship between the rates of
12
changes in the fear gauge and the returns of underlying asset is asymmetric, and that the fear
gauge better fits investors fear of the downside than it serves as a barometer of investors
excitement in a market rally. In addition to exploring the effects of VIX on trading activities,
this section examines the differential effects of fear and greed on trading activities. We
performed quantile regression to examine this topic and regressed aggregate trading values on
fear, greed, lagged trading values, lagged market returns, lagged term spread, and dummy of
weekday.
Table 4 Asymmetric effects of fear and greed on differential trading activities
This table reports results of the quantile regression of trading activity on fear, greed, and
control variables.
t l t c l t p l t l l l t l
control VIX VIX TV TV
, , 3 , , 2 , 1 , 1 , 0 , ,


. The term
TV
t
is the aggregate trading activities for all stocks. The term TV
t-1
is the lagged term of the
dependent variable (D.var_lag), and VIX
p
(VIX
c
) denotes the fear (greed) index. Other
control variables include lagged market returns (Mretrun(-1)), term spread (TS(-1)), and
weekday dummy. The term spread is the difference between the yield on a 10-year treasury
bond and the 90-day commercial paper rate. The last row presents Wald-test results for fear
and greed. ***, **, and * denote the level of significance at 1%, 5%, and 10%, respectively.
quantile D.var(-1) VIXp VIXc
Mreturn(-1)
TS(-1) constant Adj R2
0.01 0.863
***
-0.758
***
0.611
**
0.002
***
-0.115
***
2.217
***
0.572
(26.78) (-3.04) (2.00) (0.27) (-4.51) (3.71)
0.05 0.874
***
-0.661
***
0.441
**
0.003 -0.080
***
2.115
***
0.534
(36.44) (-3.75) (2.09) (0.63) (-4.04) (4.79)
0.1 0.862
***
-0.328
**
0.138 0.011
***
-0.064
***
2.377
***
0.527
(37.82) (-1.85) (0.66) (2.22) (-3.36) (5.63)
0.2 0.896
***
-0.206
***
0.164 0.014
***
-0.037
***
1.772
***
0.528
(51.12) (-2.25) (1.3) (3.7) (-2.62) (5.38)
0.3 0.880
***
-0.301
***
0.345
***
0.012
***
-0.029
***
2.123
***
0.521
(55.76) (-3.46) (2.63) (3.03) (-2.44) (7.22)
0.4 0.862
***
-0.259
***
0.400
***
0.014
***
-0.019 2.481
***
0.514
(59.28) (-2.98) (3.99) (3.19) (-1.43) (9.31)
0.5 0.847
***
-0.254
***
0.406
***
0.015
***
-0.017 2.799
***
0.508
(58.02) (-4.08) (5.63) (3.72) (-1.6) (10.25)
0.6 0.838
***
-0.239
***
0.365
***
0.015
***
-0.006 3.012
***
0.5
(61.3) (-4.11) (5.16) (4.41) (-0.54) (11.92)
0.7 0.816
***
-0.265
***
0.367
***
0.013
***
-0.001 3.473
***
0.489
(53.49) (-3.49) (4.02) (3.29) (-0.06) (12.24)
0.8 0.813
***
-0.272
***
0.393
***
0.006 0.005 3.566
***
0.475
(39.97) (-2.74) (3.97) (1.45) (0.4) (9.41)
0.9 0.744
***
-0.312
***
0.462
***
0.006 0.000 4.913
***
0.456
(27.81) (-2.69) (3.28) (1.03) (-0.01) (9.95)
0.95 0.705
***
-0.365
***
0.637
***
0.01 -0.016 5.685
***
0.452
(28.73) (-3.2) (3.69) (1.28) (-0.86) (12.28)
0.99 0.656
***
-0.373
*
0.655
**
0.024 -0.018 6.730
***
0.428
(15.53) (-1.7) (1.83) (0.65) (-0.5) (8.63)
Table 4 presents the coefficients estimated on lag trading values, fear, greed, lag market
returns, and lag term spread. For the lower trading value quantiles, the coefficient of fear is
13
negatively associated with the trading value, whereas that of greed has a positive association.
The absolute value of the coefficient of fear is greater than that of greed, implying that the
trading value reacts more negatively to fear than it reacts positively to greed. These empirical
results imply that investors are reluctant to trade when fear overcomes greed. In contrast, the
absolute value of the positive coefficient of greed is greater than that of the negative
coefficient of fear for upper trading value quantiles, suggesting that high trading values are
driven by greed more than by fear. When investors greed dominates fear, they pour money
into the stock market, producing high trading values. These empirical results support H2
0
[i.e.,
the effect of greed (fear) is relatively greater than that of fear (greed) among high (low)
trading activities].
4.5 Effects of change in fear and greed on trading activities
The previous sections presented the investigation of the associations between the level of fear
and greed and trading activities. [15] suggested that the association between falling prices and
increasing risk is stronger and more sensitive than that between rising prices and diminishing
risk. [24] showed that the negative relationship between the stock market return and VIX
change is asymmetric because VIX rises at a higher absolute rate for negative returns than for
positive returns. This section further investigates the relationship between the changes in fear
and greed and trading activities.
Figure 3 Response of aggregate trading activity to fear and greed
-.04
-.02
.00
.02
.04
1 2 3 4 5 6 7 8 9 10
Response of trading value to fear
-.04
-.02
.00
.02
.04
1 2 3 4 5 6 7 8 9 10
Response of trading value to greed
Response to Generalized One S.D. Innovations 2 S.E.
Fear and greed are powerful emotions in the stock market, and these two emotions and
trading activities act as a system. We applied the vector autoregression model (VAR) to
investigate this postulated relationship. [20] suggested that t tests on individual coefficients
do not produce reliable results, and cannot strongly support the relationship among the
variables in the system. He advocated a focus on the impulse response to random shocks. To
avoid the innovations in VAR are sensitive to variables ordering ([17]), we applied a
generalized impulses technique to examine the responses of trading activities to changes in
fear and greed ([22]). We also used the Schwarz information criterion (SIC) to identify the
appropriate lag lengths.
Figures show the impulse responses of trading activities to changes for fear and greed,
respectively. Trading activities appear to respond positively and significantly to greed during
14
the first day and reverse negatively on the third day, becoming non-significant thereafter. The
immediate positive and the subsequent negative effect of greed is consistent with the
arguments that if excessive optimism moves trading values up, periods of high trading
activities should be followed by low trading values. Although the response of trading
activities to fear is negative and significant during the first day, it becomes positive on the
second day. Similar to the results of greed, the immediate negative and subsequent positive
effect of fear is analogous to arguments that if excessive pessimism moves trading activities
down, periods of low trading activities should be followed by high trading activities.
5. CONCLUSION
This study uses the VIX method introduced in 1993 to construct the fear and greed indices
and examine the effect of fear and greed on trading activities. Results show that fear and
greed are negatively and positively, respectively, associated with trading activities. During
high trading activity quantiles, greed has a greater influence than fear, and vice versa for low
trading activities quantiles. Finally, this study shows that greed has a greater influence than
fear on stocks with low prices, low market capitalization, high returns, and high turnover.
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