Endogenous Extreme Events and the Dual Role of Prices

Posted: 1 Sep 2012

See all articles by Jon Danielsson

Jon Danielsson

London School of Economics - Systemic Risk Centre

Hyun Song Shin

Bank for International Settlements (BIS)

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group

Date Written: July 2012

Abstract

Extreme events in financial markets are often generated by shocks that come from within the system, rather than those that arrive from outside the system. The combination of risk-sensitive behavior rules and the coordinated actions implied by market-to-market accounting can result in outcome distributions with fat tails, even if the fundamental shocks are Gaussian. We illustrate such endogenous extreme events through the pricing density resulting from dynamic hedging of options and the flash crash of May 2010.

Suggested Citation

Danielsson, Jon and Shin, Hyun Song and Zigrand, Jean-Pierre, Endogenous Extreme Events and the Dual Role of Prices (July 2012). Annual Review of Economics, Vol. 4, pp. 111-129, 2012. Available at SSRN: https://ssrn.com/abstract=2139249 or http://dx.doi.org/10.1146/annurev-economics-080511-110930

Jon Danielsson (Contact Author)

London School of Economics - Systemic Risk Centre ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44.207.955.6056 (Phone)

HOME PAGE: http://www.riskreasearch.org

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

Jean-Pierre Zigrand

London School of Economics - Department of Finance, Systemic Risk Centre, and Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6201 (Phone)
+44 20 7955 7420 (Fax)

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