Leverage Effect Breakdowns & Flight from Risky Assets

Quantitative Finance, Volume 15, Issue 5, May 2015, pages 865-871.

20 Pages Posted: 8 Dec 2009 Last revised: 17 Apr 2015

See all articles by Stephen Matteo Miller

Stephen Matteo Miller

George Mason University - Mercatus Center

Date Written: May 13, 2012

Abstract

Though part of “market lore,” Black (1976) first reported the inverse relationship between price and volatility, calling it the “leverage effect.” Without providing evidence, Black (1988) claims that in the months leading up to the October ‘87 Crash the relationship changed: price and volatility both rose. Using daily data for the Old VIX, derived from S&P 100 Index option market prices, to estimate intra-quarterly regressions of implied volatility against price from Q2 1986 – Q1 2012, I can verify Black’s claim for the October ’87 Crash, and interestingly, for subsequent periods of crisis. I then analyze several Constant Elasticity of Variance optimal portfolio rules, which include the leverage effect, to show the elasticity sign switch implies that investors reduce their risky asset holdings to zero.

Keywords: Constant Elasticity of Variance model, Financial Crises, Implied Volatility, Leverage Effects, Optimal Portfolio Rules

JEL Classification: G11, G12

Suggested Citation

Miller, Stephen Matteo, Leverage Effect Breakdowns & Flight from Risky Assets (May 13, 2012). Quantitative Finance, Volume 15, Issue 5, May 2015, pages 865-871., Available at SSRN: https://ssrn.com/abstract=1520304 or http://dx.doi.org/10.2139/ssrn.1520304

Stephen Matteo Miller (Contact Author)

George Mason University - Mercatus Center ( email )

3434 Washington Blvd., 4th Floor
Arlington, VA 22201
United States

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