Derivative Choices of Retail Investors: Evidence from Germany David Nicolaus * This version: December 16 th ,2010 Abstract: During the last few years, a strong growth of retail derivative markets has been observed in a number of financial retail markets around the world. Using a unique data set, we confront in this paper several lines of arguments that have been provided to explain the observed popularity of the instrument with data from the German secondary market. We analyze a number of determinants that are likely to affect the derivative choices of retail investors. We further analyze the performance of retail derivatives chosen by retail investors and propose a new sentiment measure to analyze the information content of the observed choices for the underlying asset. Our results support previous studies that argue that an increase in the need for specifying the characteristics of financial products and consequently an increase in retail investors’ search costs contribute to the observed popularity of retail derivatives. However, the observed pattern in derivative choices also supports other studies that argue that the retail demand for derivatives is driven by systematic deviations of retail investors from rational behaviour. Our analysis of the performance of the products chosen by retail investors further reveals that the trading behaviour that is likely to underlie the observed derivative choices results in a performance loss compared to a more diversified portfolio. We conclude that retail derivative markets emphasize the importance of situational and investor specific factors for retail investors’ portfolio choices that might counteract the welfare improving potential of this instrument. Keywords: Retail derivatives, certificates, investor behaviour, momentum, contrarian, sentiment JEL Codes: G11, G12, D83 * Finance Department and Center for Financial Studies at Goethe University Frankfurt am Main, corresponding email address
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