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Multivariate Stock Returns Around Extreme Events: A Reassessment of Economic Fundamentals and the 1987 Market Crash

This paper reassesses the role of economic fundamentals in the 1987 stock market crash using a two factor common-component model of returns. The model decomposes returns into idiosyncratic components, a common white noise component, and a common source of Poisson jumps. Among three two-year sample periods for Major Market Index stocks, only a 1987-88 sample results in an estimated jump component with low frequency and large size. Using Bayes' rule, we infer ex post jump probabilities for each sample day. In contrast to an analogous univariate model for an index return, the multivariate model captures information in the cross-section of returns. Leading financial news on the most likely jump days from the multivariate model is compared with news on a control group of high index return days. Days with high jump probabilities under the multivariate model contain systematically more news related to the dollar, trade deficits, and financing of the U. S. budget deficit. This suggest that the common jump component proxies for economic fundaments related to this cluster of news events, and that the unexpectedly large U.S. trade deficit news released on the Wednesday prior to the crash provided an economic catalyst for the event.

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Paper provided by New York University, Leonard N. Stern School of Business- in its series New York University, Leonard N. Stern School Finance Department Working Paper Seires with number 99-071.

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Date of creation: Sep 1999
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Handle: RePEc:fth:nystfi:99-071
Contact details of provider: Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126
Phone: (212) 998-0100
Web page: http://w4.stern.nyu.edu/finance/
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  1. Kim, Chang-Jin & Kim, Myung-Jig, 1996. "Transient Fads and the Crash of '87," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(1), pages 41-58, Jan.-Feb..
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  3. Robert J. Shiller, 1987. "Investor Behavior in the October 1987 Stock Market Crash: Survey Evidence," NBER Working Papers 2446, National Bureau of Economic Research, Inc.
  4. Shiller, Robert J, 1990. "Speculative Prices and Popular Models," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 55-65, Spring.
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  6. Greenwald, Bruce C & Stein, Jeremy, 1988. "The Task Force Report: The Reasoning behind the Recommendations," Journal of Economic Perspectives, American Economic Association, vol. 2(3), pages 3-23, Summer.
  7. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1989. "Positive Feedback Investment Strategies and Destabilizing Rational Speculation," NBER Working Papers 2880, National Bureau of Economic Research, Inc.
  8. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  9. G. William Schwert, 1990. "Stock Volatility and the Crash of '87," NBER Working Papers 2954, National Bureau of Economic Research, Inc.
  10. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
  11. John Y. Campbell, 1990. "A Variance Decomposition for Stock Returns," NBER Working Papers 3246, National Bureau of Economic Research, Inc.
  12. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Cowles Foundation Discussion Papers 719R, Cowles Foundation for Research in Economics, Yale University.
  13. Brennan, Michael J & Schwartz, Eduardo S, 1989. "Portfolio Insurance and Financial Market Equilibrium," The Journal of Business, University of Chicago Press, vol. 62(4), pages 455-72, October.
  14. Leland, Hayne & Rubinstein, Mark, 1988. "Comments on the Market Crash: Six Months After," Journal of Economic Perspectives, American Economic Association, vol. 2(3), pages 45-50, Summer.
  15. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
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