Forecasting crashes with a smile

Ian Martin and Ran Shi

No 18524, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We derive option-implied bounds on the probability of a crash in an individual stock, and argue that the lower bound should be close to the truth a priori. Empirically, the lower bound successfully forecasts crashes both in and out of sample; and it outperforms models based on stock characteristics previously studied in the literature. In a multivariate regression, a one standard deviation increase in the bound raises the predicted crash probability by 3 percentage points, whereas a one standard deviation increase in the next most important predictor (a measure of short interest) raises the predicted probability by only 0.3 percentage points.

Keywords: Forecasting; Crashes; Options (search for similar items in EconPapers)
JEL-codes: G12 G17 (search for similar items in EconPapers)
Date: 2023-10
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Working Paper: Forecasting Crashes with a Smile (2026)
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