Anatomy of a Meltdown: The Risk Neutral Density for the S&P 500 in the Fall of 2008

33 Pages Posted: 5 May 2009 Last revised: 16 Sep 2009

See all articles by Justin Birru

Justin Birru

New York University - Stern School of Business

Stephen Figlewski

New York University - Stern School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: April 22, 2009

Abstract

We examine the intraday behavior of the risk neutral probability density (RND) for the Standard and Poor's 500 Index extracted from a continuous real-time data feed of bid and ask quotes for index options. This allows an exceptionally detailed view of how investors' expectations about returns and attitudes towards risk fluctuated during the financial crisis in the fall of 2008. The increase in risk measures was extraordinary, such as a fivefold increase in minute-to-minute volatility from October 2006 to October 2008. In contrast to moderate positive autocorrelation in the S&P index, the analysis reveals unusually large negative autocorrelation in the mean and standard deviation of the RND. Using quantile regressions, we find a strong pattern in how much different portions of the RND move when the level of the stock index changes, with the middle portion of the RND amplifying the change in the index by a factor of as much as 1.5 or more in some cases. This phenomenon increased in size during the crisis and, surprisingly, was stronger for up moves than for down moves in the market.

Keywords: risk neutral density, market expectations, 2008 financial crisis, option valuation

JEL Classification: G13, G14, D84, G12

Suggested Citation

Birru, Justin and Figlewski, Stephen, Anatomy of a Meltdown: The Risk Neutral Density for the S&P 500 in the Fall of 2008 (April 22, 2009). Available at SSRN: https://ssrn.com/abstract=1396380 or http://dx.doi.org/10.2139/ssrn.1396380

Justin Birru

New York University - Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States
212-998-0576 (Phone)

Stephen Figlewski (Contact Author)

New York University - Stern School of Business ( email )

44 West 4th Street
Department of Finance Suite 9-160
New York, NY 10012-1126
United States
212-998-0712 (Phone)
212-995-4220 (Fax)

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