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Explaining asset pricing puzzles associated with the 1987 market crash

  • Benzoni, Luca
  • Collin-Dufresne, Pierre
  • Goldstein, Robert S.

The 1987 market crash was associated with a dramatic and permanent steepening of the implied volatility curve for equity index options, despite minimal changes in aggregate consumption. We explain these events within a general equilibrium framework in which expected endowment growth and economic uncertainty are subject to rare jumps. The arrival of a jump triggers the updating of agents' beliefs about the likelihood of future jumps, which produces a market crash and a permanent shift in option prices. Consumption and dividends remain smooth, and the model is consistent with salient features of individual stock options, equity returns, and interest rates.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 101 (2011)
Issue (Month): 3 (September)
Pages: 552-573

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Handle: RePEc:eee:jfinec:v:101:y:2011:i:3:p:552-573
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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