Discussion Papers, Department of Finance and Management Science, Norwegian School of Economics (NHH)
No 2008/25:
The Propagation of Financial Extremes
Lorán Chollete ()
Abstract: What drives extreme economic events? Motivated by recent
theory, and events in US subprime markets, we begin to open the black box
of extremes. Specifically, we extend standard economic analysis of extreme
risk, allowing for dynamics and endogeneity. We explain how endogenous
extremes may arise in an economy of individuals who engage in resource
transfers. Our model suggests that susceptibility to extremes depends on
differences in marginal substitution rates. Using over a century of daily
stock price data, we construct empirical probabilities of extremes, and
document interesting dynamic behavior. We find evidence that extremes are
endogenous. This latter finding raises the possibility that control of
extremes is a public good, and that extreme events may be an important
market failure for regulators and central banks to correct.
Keywords: Extreme Event; Subprime Market; Dynamics; Endogeneity; Public Good; Central Bank Policy; (follow links to similar papers)
JEL-Codes: C10; D62; E44; E51; G18; H23; H41; (follow links to similar papers)
38 pages, February 10, 2009
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