Transient Fads and the Crash of '87

Chang-Jin Kim () and Myung-Jig Kim

Journal of Applied Econometrics, 1996, vol. 11, issue 1, 41-58

Abstract: Using a fad model with Markov-switching heteroscedasticity in both the fundamental and fad components (UC-MS model), this paper examines the possibility that the 1987 stock market crash was an example of a short-lived fad. While we usually think of fads as speculative bubbles, what the UC-MS model seems to be picking up is unwarranted pessimism which the market exhibited with the OPEC oil shock and the '87 crash. Furthermore, the conditional variance implied by the UC-MS model captures most of the dynamics in the GARCH specification of stock return volatility. Yet unlike the GARCH measure of volatility, the UC-MS measure of volatility is consistent with volatility reverting to its normal level very quickly after the crash. Copyright 1996 by John Wiley & Sons, Ltd.

Date: 1996
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