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The Propagation of Financial Extremes

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Author Info
Chollete, Lorán () (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
Abstract

What drives extreme economic events? Motivated by recent theory, and events in US subprime markets, we begin to open the black box of extremes. Specifically, we extend standard economic analysis of extreme risk, allowing for dynamics and endogeneity. We explain how endogenous extremes may arise in an economy of individuals who engage in resource transfers. Our model suggests that susceptibility to extremes depends on differences in marginal substitution rates. Using over a century of daily stock price data, we construct empirical probabilities of extremes, and document interesting dynamic behavior. We find evidence that extremes are endogenous. This latter finding raises the possibility that control of extremes is a public good, and that extreme events may be an important market failure for regulators and central banks to correct.

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Publisher Info
Paper provided by Department of Finance and Management Science, Norwegian School of Economics and Business Administration in its series Discussion Papers with number 2008/25.

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Length: 38 pages
Date of creation: 10 Feb 2009
Date of revision:
Handle: RePEc:hhs:nhhfms:2008_025

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Postal: NHH, Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway
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Fax: +47 55 95 96 50
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Web page: http://www.nhh.no/for/
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Related research
Keywords: Extreme Event; Subprime Market; Dynamics; Endogeneity; Public Good; Central Bank Policy;

Find related papers by JEL classification:
C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - General
D62 - Microeconomics - - Welfare Economics - - - Externalities
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
H41 - Public Economics - - Publicly Provided Goods - - - Public Goods

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