Statistical modelling of financial crashes: Rapid growth, illusion of certainty and contagion

John Fry

MPRA Paper from University Library of Munich, Germany

Abstract: We develop a rational expectations model of financial bubbles and study ways in which a generic risk-return interplay is incorporated into prices. We retain the interpretation of the leading Johansen-Ledoit-Sornette model, namely, that the price must rise prior to a crash in order to compensate a representative investor for the level of risk. This is accompanied, in our stochastic model, by an illusion of certainty as described by a decreasing volatility function. The basic model is then extended to incorporate multivariate bubbles and contagion, non-Gaussian models and models based on stochastic volatility. Only in a stochastic volatility model where the mean of the log-returns is fixed does volatility increase prior to a crash.

Keywords: financial crashes; super-exponential growth; illusion of certainty; contagion (search for similar items in EconPapers)
JEL-codes: C00 E30 G10 (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-upt
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Related works:
Working Paper: Statistical modelling of financial crashes: Rapid growth, illusion of certainty and contagion (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:16027

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