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

Eric Hillebrand ()

Departmental Working Papers from Department of Economics, Louisiana State University

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.

Date: 2003-10
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Related works:
Working Paper: The Effects of Japanese Foreign Exchange Intervention, GARCH Estimation and Change Point Detection (2004)
Working Paper: The Effects of Japanese Foreign Exchange Intervention: GARCH Estimation and Change Point Detection (2004)
Working Paper: The Effects of Japanese Foreign Exchange Intervention: GARCH Estimation and Change Point Detection (2003)
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