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A0420
Title: The normal before the crises: The volatility and skewness crystal ball Authors:  Radu Tunaru - University of Kent (United Kingdom) [presenting]
Teng Zheng - University of Kent (United Kingdom)
Abstract: Merton's jump-diffusion model coupled with Markov Chain Monte Carlo inferential techniques are used to capture the volatility and skewness of the S\&P500 index between 1980 and 2015 accounting for parameter estimation risk. We find that the subprime crisis has been preceded a long period when the equity market returns distribution reverted back to a Gaussian distribution indicating a very calm period without extreme events. This event only happened in the U.S. market, where the 2008 crisis originated, and it did not occur in other major economies like Eurozone, the U.K., Germany, Japan or China. Our empirical results are in line with the Minsky theory, and also confirms the theory of endogenous risk. When a calm period is observed, a high level of market sentiment leads to an extra negative impact to the subsequent market returns. Accounting for the interaction between normality and levels of sentiment, this effect may encourage extra risk taking and over expectation of future growth.