Explaining asset pricing puzzles associated with the 1987 market crash

Luca Benzoni, Pierre Collin-Dufresne and Robert S. Goldstein

No WP-2010-10, Working Paper Series from Federal Reserve Bank of Chicago

Abstract: The 1987 market crash was associated with a dramatic and permanent steepening of the implied volatility curve for equity index options, despite minimal changes in aggregate consumption. We explain these events within a general equilibrium framework in which expected endowment growth and economic uncertainty are subject to rare jumps. The arrival of a jump triggers the updating of agents' beliefs about the likelihood of future jumps, which produces a market crash and a permanent shift in option prices. Consumption and dividends remain smooth, and the model is consistent with salient features of individual stock options, equity returns, and interest rates.

Keywords: Asset pricing; Prices; Markets (search for similar items in EconPapers)
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Date: 2010
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