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The Propagation of Financial Extremes

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  • Chollete, Lorán

    ()
    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

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    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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    Bibliographic Info

    Paper provided by Department of Business and Management Science, Norwegian School of Economics 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 Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
    Phone: +47 55 95 92 93
    Fax: +47 55 95 96 50
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    Web page: http://www.nhh.no/en/research-faculty/department-of-business-and-management-science.aspx
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    Related research

    Keywords: Extreme Event; Subprime Market; Dynamics; Endogeneity; Public Good; Central Bank Policy;

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