Underreaction, overreaction, and increasing misreaction to information in the options market

This paper investigates options market reaction to changes in the instantan eous Variance of the underlying asset. There are three main findings. First , options market investors underreact to individual daily changes in instan taneous variance. Second, these same investors overreact to periods of most ly increasing or mostly decreasing daily changes in instantaneous variance. Third, they tend to underreact (overreact) to current daily changes in ins tantaneous variance that are preceded mostly by daily changes of the opposi te (same) sign. The third finding can reconcile the first two and is also c onsistent with well-established cognitive biases.