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Crash of ’87 - Was it Expected? Aggregate Market Fears and Long Range Dependence

Listed author(s):
  • Ramazan Gencay

    ()

    (Department of Economics, Simon Fraser University)

  • Nikola Gradojevic

    ()

    (Faculty of Business Administration, Lakehead University)

We develop a dynamic framework to identify aggregate market fears ahead of a major market crash through the skewness premium of European options. Our methodology is based on measuring the distribution of a skewness premium through a q-Gaussian density and a maximum entropy principle. Our findings indicate that the October 19th, 1987 crash was predictable from the study of the skewness premium of deepest out-of-the-money options about two months prior to the crash.

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File URL: http://www.rcfea.org/RePEc/pdf/wp28_09.pdf
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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 28_09.

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Date of creation: Jan 2009
Handle: RePEc:rim:rimwps:28_09
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  1. Tong, S. & Bezerianos, A. & Paul, J. & Zhu, Y. & Thakor, N., 2002. "Nonextensive entropy measure of EEG following brain injury from cardiac arrest," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 305(3), pages 619-628.
  2. Bates, David S, 1991. " The Crash of '87: Was It Expected? The Evidence from Options Markets," Journal of Finance, American Finance Association, vol. 46(3), pages 1009-1044, July.
  3. Tabak, Benjamin M. & Cajueiro, Daniel O., 2006. "Assessing inefficiency in euro bilateral exchange rates," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 367(C), pages 319-327.
  4. Garcia, Rene & Gencay, Ramazan, 2000. "Pricing and hedging derivative securities with neural networks and a homogeneity hint," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 93-115.
  5. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
  6. Gradojevic, Nikola & Gencay, Ramazan, 2008. "Overnight interest rates and aggregate market expectations," Economics Letters, Elsevier, vol. 100(1), pages 27-30, July.
  7. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
  8. Mandelbrot, Benoit B, 1971. "When Can Price Be Arbitraged Efficiently? A Limit to the Validity of the Random Walk and Martingale Models," The Review of Economics and Statistics, MIT Press, vol. 53(3), pages 225-236, August.
  9. Gamero, L.G. & Plastino, A. & Torres, M.E., 1997. "Wavelet analysis and nonlinear dynamics in a nonextensive setting," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 246(3), pages 487-509.
  10. Celia Anteneodo & Constantino Tsallis, 2003. "Risk aversion in financial decisions: A nonextensive approach," Papers cond-mat/0306605, arXiv.org.
  11. Bates, David S., 2000. "Post-'87 crash fears in the S&P 500 futures option market," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 181-238.
  12. Kitamura, Yuichi & Stutzer, Michael, 2002. "Connections between entropic and linear projections in asset pricing estimation," Journal of Econometrics, Elsevier, vol. 107(1-2), pages 159-174, March.
  13. Silvio M. Duarte Queiros & Luis G. Moyano & Jeferson de Souza & Constantino Tsallis, 2006. "A nonextensive approach to the dynamics of financial observables," Papers physics/0601222, arXiv.org.
  14. Rappoport, Peter & White, Eugene N, 1994. "Was the Crash of 1929 Expected?," American Economic Review, American Economic Association, vol. 84(1), pages 271-281, March.
  15. Grech, D & Mazur, Z, 2004. "Can one make any crash prediction in finance using the local Hurst exponent idea?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 336(1), pages 133-145.
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