Differences of Opinion, Rational Arbitrage and Market Crashes / Harrison Hong, Jeremy C. Stein.

Format:

Book

Author/Creator:

Hong, Harrison.

Contributor:

National Bureau of Economic Research.

Stein, Jeremy C.

Series:

Working Paper Series (National Bureau of Economic Research) no. w7376.

NBER working paper series no. w7376

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1999.

Summary:

We develop a theory of stock-market crashes based on differences of opinion among investors. Because of short-sales constraints, bearish investors do not initially participate in the market and their information is not revealed in prices. However, if other, previously-bullish investors have a change of heart and bail out of market, the originally-more-bearish group may become the marginal "support buyers", and hence more will be learned about their signals. Thus accumulated hidden information tends to come out during market declines. The model helps explain a variety of stylized facts, including: 1) large movements in prices unaccompanied by significant news about fundamentals; 2) negative skewness in the distribution of market returns; and 3) increased correlation among stocks in a falling market. In addition, the model makes a distinctive out-of-sample prediction: that negative skewness will be most pronounced conditional on high trading volume.

Notes:

Print version record

October 1999.