Crash of '87 - Was it Expected? Aggregate Market Fears and Long Range Dependence
Simon Fraser University
University of Guelph, Department of Economics and Finance; University of Bologna - Rimini Center for Economic Analysis (RCEA)
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.
Number of Pages in PDF File: 23
Keywords: Non-additive Entropy, Shannon Entropy, Tsallis Entropy, q-Gaussian Distribution.
JEL Classification: G1, C40
Date posted: January 27, 2007