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Institutional Investors and Stock Market Volatility

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Author Info
Xavier Gabaix
Parameswaran Gopikrishnan
Vasiliki Plerou
H. Eugene Stanley

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Abstract

We present a theory of excess stock market volatility, in which market movements are due to trades by very large institutional investors in relatively illiquid markets. Such trades generate significant spikes in returns and volume, even in the absence of important news about fundamentals. We derive the optimal trading behavior of these investors, which allows us to provide a unified explanation for apparently disconnected empirical regularities in returns, trading volume and investor size.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11722.

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Date of creation: Nov 2005
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Handle: RePEc:nbr:nberwo:11722

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Find related papers by JEL classification:
G1 - Financial Economics - - General Financial Markets
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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  1. Robert J. Barro & Tao Jin, 2009. "On the Size Distribution of Macroeconomic Disasters," NBER Working Papers 15247, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. B. Craven & Sardar Islam, 2008. "A model for stock market returns: non-Gaussian fluctuations and financial factors," Review of Quantitative Finance and Accounting, Springer, vol. 30(4), pages 355-370, May. [Downloadable!] (restricted)
  3. Tobias Adrian & Joshua Rosenberg, 2006. "Stock returns and volatility: pricing the short-run and long-run components of market risk," Staff Reports 254, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  4. Chollete, Lorán, 2009. "The Propagation of Financial Extremes," Discussion Papers 2008/25, Department of Finance and Management Science, Norwegian School of Economics and Business Administration. [Downloadable!]
  5. Xavier Gabaix & Arvind Krishnamurthy & Olivier Vigneron, 2005. "Limits of Arbitrage: Theory and Evidence from the Mortgage-Backed Securities Market," NBER Working Papers 11851, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Wei-Xing Zhou, 2007. "Universal price impact functions of individual trades in an order-driven market," Quantitative Finance Papers 0708.3198, arXiv.org, revised Apr 2008. [Downloadable!]
  7. Xavier Gabaix, 2008. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," NBER Working Papers 13724, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," NBER Working Papers 12365, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  9. Ádám G. Zawadowski & György Andor & János Kertész, 2006. "Short-term market reaction after extreme price changes of liquid stocks," Quantitative Finance, Taylor and Francis Journals, vol. 6(4), pages 283-295, August. [Downloadable!] (restricted)
  10. Makoto Nirei, 2008. "Self-organized criticality in a herd behavior model of financial markets," Journal of Economic Interaction and Coordination, Springer, vol. 3(1), pages 89-97, June. [Downloadable!] (restricted)
  11. Y. Malevergne & D. Sornette, 2007. "A two-Factor Asset Pricing Model and the Fat Tail Distribution of Firm Sizes," Quantitative Finance Papers physics/0702027, arXiv.org. [Downloadable!]
  12. Xavier Gabaix, 2007. "Linearity-Generating Processes: A Modelling Tool Yielding Closed Forms for Asset Prices," NBER Working Papers 13430, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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