The Market for Crash Risk

David S. Bates

No 8557, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper examines the equilibrium when negative stock market jumps (crashes) can occur, and investors have heterogeneous attitudes towards crash risk. The less crash-averse insure the more crash-averse through the options markets that dynamically complete the economy. The resulting equilibrium is compared with various option pricing anomalies reported in the literature: the tendency of stock index options to overpredict volatility and jump risk, the Jackwerth (2000) implicit pricing kernel puzzle, and the stochastic evolution of option prices. The specification of crash aversion is compatible with the static option pricing puzzles, while heterogeneity partially explains the dynamic puzzles. Heterogeneity also magnifies substantially the stock market impact of adverse news about fundamentals.

JEL-codes: G13 (search for similar items in EconPapers)
Date: 2001-10
New Economics Papers: this item is included in nep-fmk
Note: AP
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Citations: View citations in EconPapers (16)

Published as Bates, David S. "The Market for Crash Risk." Journal of Economic Dynamics and Control 32, 7 (July 2008): 2291-2321.

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