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Amplification and asymmetry in crashes and frenzies

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  • Han Ozsoylev

    ()

Abstract

We often observe disproportionate reactions to tangible information in large stock price movements. Moreover these movements feature an asymmetry: the number of crashes is more than that of frenzies in the S&P 500 index. This paper offers an explanation for these two characteristics of large movements in which hedging (portfolio insurance) causes amplified price reactions to news and liquidity shocks as well as an asymmetry biased towards crashes. Risk aversion of traders is shown to be essential for the asymmetry of price movements. Also, we show that differential information enhances both amplification and asymmetry delivered by hedging.

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File URL: http://hdl.handle.net/10.1007/s10436-007-0077-z
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Bibliographic Info

Article provided by Springer in its journal Annals of Finance.

Volume (Year): 4 (2008)
Issue (Month): 2 (March)
Pages: 157-181

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Handle: RePEc:kap:annfin:v:4:y:2008:i:2:p:157-181

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Web page: http://www.springerlink.com/link.asp?id=112370

Related research

Keywords: Amplification; Asymmetry; Crash; Frenzy; Hedging; Portfolio insurance; G11; G12;

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  1. Michele Boldrin & David K. Levine, 2000. "Growth cycles and market crashes," Staff Report 279, Federal Reserve Bank of Minneapolis.
  2. Zeira, Joseph, 1993. "Informational Overshooting, Booms and Crashes," CEPR Discussion Papers 823, C.E.P.R. Discussion Papers.
  3. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
  4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  5. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
  6. Demange, G. & Laroque, G., 1992. "Private Information and the Design of Securities," DELTA Working Papers 92-22, DELTA (Ecole normale supérieure).
  7. Van Nieuwerburgh, Stijn & Veldkamp, Laura, 2006. "Learning asymmetries in real business cycles," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 753-772, May.
  8. David M. Cutler & James M. Poterba & Lawrence H. Summers, 1989. "What Moves Stock Prices?," NBER Working Papers 2538, National Bureau of Economic Research, Inc.
  9. Martin Chalkley & In Ho Lee, 1998. "Learning and Asymmetric Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(3), pages 623-645, July.
  10. Veronesi, Pietro, 1999. "Stock Market Overreaction to Bad News in Good Times: A Rational Expectations Equilibrium Model," Review of Financial Studies, Society for Financial Studies, vol. 12(5), pages 975-1007.
  11. Admati, Anat R, 1985. "A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets," Econometrica, Econometric Society, vol. 53(3), pages 629-57, May.
  12. Veldkamp, Laura L., 2005. "Slow boom, sudden crash," Journal of Economic Theory, Elsevier, vol. 124(2), pages 230-257, October.
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Cited by:
  1. Yue Peng & Wing Ng, 2012. "Analysing financial contagion and asymmetric market dependence with volatility indices via copulas," Annals of Finance, Springer, vol. 8(1), pages 49-74, February.

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