Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2008/2: The Propagation of Financial Extremes: An Application to Subprime Market Spillovers

Lorán Chollete ()
Additional contact information
Lorán Chollete: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: What drives extreme and rare economic events? Motivated by recent theory, and events in US subprime markets, we begin to open the black box of extremes. Specifically, we build a taxonomy of extremes, then extend standard economic analysis of extreme risk. First, we model the potentially relevant dimensions of dynamics and endogeneity. In characterizing individuals' endogenous propagation of extremes, we relate the latter to public goods. Second, using over a century of daily stock price data, we construct empirical probabilities of extremes. We document that extremes are relatively frequent and persistent. We find evidence that extremes are endogenous, raising the possibility that control of extremes is a public good.

Keywords: Extreme event; Subprime Market; Dynamics; Endogeneity; Public Good

JEL-codes: C10; E44; E51; H23; H41

58 pages, January 31, 2008

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