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The Effects of Japanese Foreign Exchange Intervention: GARCH Estimation and Change Point Detection

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Abstract

Errors in the perception of mean-reversion expectations can cause stockmarket crashes. This view was proposed by Fischer Black after the stockmarket crash of 1987. I discuss this concept and specify a stock-price model with mean-reversion in returns. Using daily data of the Dow Jones Industrial Average and the S&P500 index I show that mean-reversion in returns is a transient but recurring phenomenon. In the case of the crash of 1987 I show that during the period 1982�1986 mean-reversion was higher than during the nine months prior to the crash. This indicates that mean-reversion expectations were underestimated in 1987. This error was disclosed when in the week prior to the crash it became known that a surprisingly high volume of equities was under portfolio insurance and thus hedged against a faster reversion. Simulations of the model with parameter estimates obtained from the two periods show that a crash of 20 percent or more had a probability of about seven percent. Up to five years after the crash, mean-reversion was higher than before. This supports Black�s hypothesis. Contrary to that, the crash of 1929 cannot be explained by a mean-reversion illusion.

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  • Eric Hillebrand, 2003. "The Effects of Japanese Foreign Exchange Intervention: GARCH Estimation and Change Point Detection," Departmental Working Papers 2003-10, Department of Economics, Louisiana State University.
    • Handle: RePEc:lsu:lsuwpp:2003-10
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    More about this item

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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