The Propagation of Financial Extremes

Lorán Chollete ()
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Lorán Chollete: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway, http://www.nhh.no/Default.aspx?ID=2016

No 2008/25, Discussion Papers from Norwegian School of Economics, Department of Business and Management Science

Abstract: What drives extreme economic events? Motivated by recent theory, and events in US subprime markets, we begin to open the black box of extremes. Specifically, we extend standard economic analysis of extreme risk, allowing for dynamics and endogeneity. We explain how endogenous extremes may arise in an economy of individuals who engage in resource transfers. Our model suggests that susceptibility to extremes depends on differences in marginal substitution rates. Using over a century of daily stock price data, we construct empirical probabilities of extremes, and document interesting dynamic behavior. We find evidence that extremes are endogenous. This latter finding raises the possibility that control of extremes is a public good, and that extreme events may be an important market failure for regulators and central banks to correct.

Keywords: Extreme Event; Subprime Market; Dynamics; Endogeneity; Public Good; Central Bank Policy (search for similar items in EconPapers)
JEL-codes: C10 D62 E44 E51 G18 H23 H41 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2009-02-10
New Economics Papers: this item is included in nep-cba, nep-mac, nep-rmg and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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