The Role of diversification risk in financial bubbles
We present an extension of the Johansen-Ledoit-Sornette (JLS) model to include an additional pricing factor called the ``Zipf factor'', which describes the diversification risk of the stock market portfolio. Keeping all the dynamical characteristics of a bubble described in the JLS model, the new model provides an additional information about the concentration of stock gains over time. This allows us to understand better the risk diversification and to explain the investors' behavior during the bubble generation. We apply this new model to two famous Chinese stock bubbles, from August 2006 to October 2007 (bubble 1) and from October 2008 to August 2009 (bubble 2). The Zipf factor is found highly significant for bubble 1, corresponding to the fact that valuation gains were more concentrated on the large firms of the Shanghai index. It is likely that the widespread acknowledgement of the 80-20 rule in the chinese media and discussion fora led many investors to discount the risk of a lack of diversification, therefore enhancing the role of the Zipf factor. For bubble 2, the Zipf factor is found marginally relevant, suggesting a larger weight of market gains on small firms. We interpret this result as the consequence of the response of the chinese economy to the very large stimulus provided by the Chinese government in the aftermath of the 2008 financial crisis.
|Date of creation:|
|Contact details of provider:|| Postal: ETH Zentrum KPL F 38.1, Kreuzplatz 5, 8032 Zürich|
Phone: +41 1 632 57 18
Fax: +41 1 632 10 47
Web page: http://web.sg.ethz.ch/wps
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:stz:wpaper:eth-rc-11-003. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Claudio J. Tessone)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.