Large Price Changes and Pervasive Non-Linearity in Financial Markets: Implications and Interpretations

47 Pages Posted: 24 Mar 2017

See all articles by Shima Amini

Shima Amini

University of Leeds; University of Leeds - Division of Accounting and Finance

Robert Hudson

Hull University Business School (HUBS)

Jian Wang

University of Hull

Andrew Urquhart

ICMA Centre, Henley Business School

Date Written: March 24, 2017

Abstract

We show that expected returns on US stocks and all major stock world market indices are non-linearly dependent on previous returns. The expected sign of returns tends to reverse after large price movements and trends tend to continue after small movements. This property can be captured by a simple polynomial model. Incorrectly fitting a simple linear model to the data leads to substantial bias in coefficient estimates and the polynomial model can be used to eliminate trends in the data. In addition, well known technical trading rules may be substantially driven by the non-linear behavior observed.

Keywords: Stock Return; Predictability; Large Price Changes; Autocorrelation; Non-linearity; Technical Trading

JEL Classification: G01, G10, G14

Suggested Citation

Amini, Shima and Hudson, Robert and Wang, Jian and Urquhart, Andrew, Large Price Changes and Pervasive Non-Linearity in Financial Markets: Implications and Interpretations (March 24, 2017). Leeds University Business School Working Paper No. 18-03. Available at SSRN: https://ssrn.com/abstract=2940185 or http://dx.doi.org/10.2139/ssrn.2940185

Shima Amini (Contact Author)

University of Leeds ( email )

Leeds, LS2 9JT
United Kingdom

University of Leeds - Division of Accounting and Finance ( email )

Leeds LS2 9JT
United Kingdom

Robert Hudson

Hull University Business School (HUBS) ( email )

Hull, HU6 7RX
United Kingdom

Jian Wang

University of Hull ( email )

Cottingham Road
Hull, Great Britain HU6 7RX
United Kingdom

Andrew Urquhart

ICMA Centre, Henley Business School ( email )

University of Reading
Whiteknights
Reading, Berkshire RG6 6BA
United Kingdom

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