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On the Possibility of Stock Market Crashes in the Absence of Portfolio Insurance

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  • Gadi Barlevy
  • Pietro Veronesi

Abstract

stock market crash on hedging strategies by portfolio insurers, which dictated selling stocks as soon as prices fell. The fact that the practice of buying and selling stocks as portfolio insurance has virtually disappeared since then has given many comfort that a replay of the 1987 crash, when prices fell so much so quickly, is unlikely. This note argues with this view by developing a model in which crashes are possible in the absence of portfolio insurance. In our model, a crash is driven by panic selling among rational but uninformed traders.

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Bibliographic Info

Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1252.

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Date of creation: Jan 1999
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Handle: RePEc:nwu:cmsems:1252

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Related research

Keywords: Giffen Effect; Portfolio Insurance; Hedging Demand; Market Crashes;

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References

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  1. Sanford Grossman, 1978. "Further results on the informational efficiency of competitive stock markets," Special Studies Papers 114, Board of Governors of the Federal Reserve System (U.S.).
  2. Gadi Barlevy & Pietro Veronesi, . "Information Acquisition in Financial Markets," CRSP working papers 484, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  3. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
  4. Jeremy Bulow & Paul Klemperer, 1991. "Rational Frenzies and Crashes," NBER Technical Working Papers 0112, National Bureau of Economic Research, Inc.
  5. Madrigal, Vicente & Scheinkman, Jose A., 1997. "Price Crashes, Information Aggregation, and Market-Making," Journal of Economic Theory, Elsevier, vol. 75(1), pages 16-63, July.
  6. Admati, Anat R, 1985. "A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets," Econometrica, Econometric Society, vol. 53(3), pages 629-57, May.
  7. Wilson, Charles A, 1979. "Equilibrium and Adverse Selection," American Economic Review, American Economic Association, vol. 69(2), pages 313-17, May.
  8. Grossman, Sanford, 1978. "Further results on the informational efficiency of competitive stock markets," Journal of Economic Theory, Elsevier, vol. 18(1), pages 81-101, June.
  9. Charles Wilson, 1980. "The Nature of Equilibrium in Markets with Adverse Selection," Bell Journal of Economics, The RAND Corporation, vol. 11(1), pages 108-130, Spring.
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