Failing to forecast rare events

Philip Bond and James Dow

Journal of Financial Economics, 2021, vol. 142, issue 3, 1001-1016

Abstract: Do more talented traders prefer to bet on and against rare events or common events? Bets on rare events include out of the money options. Bets against rare events include the carry trade and investment grade bonds. In a model where traders specialize, equilibrium pricing reflects trading ability: A market with more skilled traders has a larger bid ask spread. We show that lower skill traders bet on and against rare events, while higher skill traders bet on and against frequent events, leading to higher bid-ask spreads in common event assets, and reducing financial markets’ ability to predict rare events.

Keywords: Bid ask spread; Information production; Rare event; Black swan (search for similar items in EconPapers)
JEL-codes: G01 G14 G17 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:142:y:2021:i:3:p:1001-1016

DOI: 10.1016/j.jfineco.2021.06.028

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