The Chinese Warrants Bubble: Evidence from Brokerage Account Records

We use brokerage account records to study trading during the Chinese put warrants bubble and find evidence consistent with extrapolative theories of speculative asset price bubbles. We identify the event that started the bubble and show that investors engaged in a form of feedback trading based on their own past returns. The interaction of feedback trading with the precipitating event caused additional buying and price increases in a feedback loop, and estimates of the trading volume due to this mechanism explain prices and returns during the bubble.

The Chinese Warrants Bubble

In 2005–2008, over a dozen put warrants traded in China went so deep out of the money that they were almost certain to expire worthless. Nonetheless, each warrant was traded more than three times each day at substantially inflated prices. This bubble is unique in that the underlying stock prices make warrant fundamentals publicly observable and that warrants have predetermined finite maturities. This sample allows us to examine a set of bubble theories. In particular, our analysis highlights the joint effects of short-sales constraints and heterogeneous beliefs in driving bubbles and confirms several key findings of the experimental bubble literature. (JEL G12, G13, O16, P34)