Explaining asset pricing puzzles associated with the 1987 market crash

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

Journal of Financial Economics, 2011, vol. 101, issue 3, 552-573

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: Volatility; smile; Volatility; smirk; Implied; volatility; Option; pricing; Portfolio; insurance (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (84)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:101:y:2011:i:3:p:552-573

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