Crash of '87 - Was it Expected? Aggregate Market Fears and Long Range Dependence

Gencay, Ramazan; Gradojevic, Nikola

doi:10.2139/ssrn.959547

Download This Paper

Open PDF in Browser

Add Paper to My Library

Crash of '87 - Was it Expected? Aggregate Market Fears and Long Range Dependence

23 Pages Posted: 27 Jan 2007

See all articles by Ramazan Gencay

Nikola Gradojevic

University of Guelph, Department of Economics and Finance; University of Bologna - Rimini Center for Economic Analysis (RCEA)

Date Written: 2006

Abstract

We develop a dynamic framework to identify aggregate market fears ahead of a major market crash through the skewness premium of European options. Our methodology is based on measuring the distribution of a skewness premium through a q-Gaussian density and a maximum entropy principle. Our findings indicate that the October 19th, 1987 crash was predictable from the study of the skewness premium of deepest out-of-the-money options about two months prior to the crash.

Keywords: Non-additive Entropy, Shannon Entropy, Tsallis Entropy, q-Gaussian Distribution.

JEL Classification: G1, C40

Suggested Citation: Suggested Citation

Gencay, Ramazan and Gradojevic, Nikola, Crash of '87 - Was it Expected? Aggregate Market Fears and Long Range Dependence (2006). Available at SSRN: https://ssrn.com/abstract=959547 or http://dx.doi.org/10.2139/ssrn.959547