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Extreme returns: The case of currencies

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  • Osler, Carol
  • Savaser, Tanseli

Abstract

Financial market crashes can occur even in the absence of news. This paper highlights four properties of price-contingent trading that increase the frequency of such events. Price-contingent trading is common across financial market, since it includes algorithmic trading, technical trading, and dynamic option hedging. The four properties we consider are: (1) high kurtosis in the distribution of order sizes; (2) clustering of trades within the day; (3) clustering of trades at certain prices; and (4) feedback between trading and returns. The paper estimates the relative importance of these factors using data from the foreign exchange market. Calibrated simulations indicate that interactions among these factors are at least as important as any single one. Among individual factors, the orders' size distribution and feedback effects have the strongest influence. Overall, price-contingent trading could account for half of realized excess kurtosis. The paper suggests that extreme returns unaccompanied by news are statistically inevitable in the presence of price-contingent trading.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 35 (2011)
Issue (Month): 11 (November)
Pages: 2868-2880

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Handle: RePEc:eee:jbfina:v:35:y:2011:i:11:p:2868-2880

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Web page: http://www.elsevier.com/locate/jbf

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Keywords: Crash risk Fat tails Exchange rates High frequency Microstructure Jump process Value-at-risk;

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As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Stop Orders Drive Half of Abnormal Currency Moves, Suggests Research
    by admin in HistorySquared on 2011-06-29 19:03:19
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
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Cited by:
  1. Michael King & Carol Osler & Dagfinn Rime, 2012. "The Market Microstructure Approach to Foreign Exchange: Looking Back and Looking Forward," Working Papers 54, Brandeis University, Department of Economics and International Businesss School.

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