Differences of Opinion, Short-Sales Constraints, and Market Crashes

We develop a theory of market crashes based on differences of opinion among investors. Because of short-sales constraints, bearish investors do not initially participate in the market and their information is not revealed in prices. However, if other previously bullish investors bail out of the market, the originally bearish group may become the marginal "support buyers," and more will be learned about their signals. Thus accumulated hidden information comes out during market declines. The model explains a variety of stylized facts about crashes and also makes a distinctive new prediction--that returns will be more negatively skewed conditional on high trading volume. Copyright 2003, Oxford University Press.

[1]  David M. Kreps,et al.  Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations , 1978 .

[2]  M. Watson,et al.  Bubbles, Rational Expectations and Financial Markets , 1982 .

[3]  A. Christie,et al.  The stochastic behavior of common stock variances: value , 1982 .

[4]  R. Pindyck.  Risk, Inflation, and the Stock Market , 1983 .

[5]  J. Poterba,et al.  The Persistence of Volatility and Stock Market Fluctuations , 1984 .

[6]  R. Roll.  Orange Juice and Weather , 1984 .

[7]  K. French,et al.  Stock return variances: The arrival of information and the reaction of traders , 1986 .

[8]  Robert E. Verrecchia,et al.  Constraints on short-selling and asset price adjustment to private information , 1987 .

[9]  Sanford J. Grossman,et al.  An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies , 1987 .

[10]  K. French,et al.  Expected stock returns and volatility , 1987 .

[11]  J. Poterba,et al.  What moves stock prices? , 1988 .

[12]  G. Schwert.  Why Does Stock Market Volatility Change Over Time? , 1988 .

[13]  R. Roll.  R-S1-2 , 1988 .

[14]  K. West,et al.  Bubbles, Fads, and Stock Price Volatility Tests: a Partial Evaluation , 1988 .

[15]  Gerard Gennotte and Hayne Leland..  Market Liquidity, Hedging and Crashes , 1989 .

[16]  Robert P. Flood,et al.  On Testing for Speculative Bubbles , 1990 .

[17]  L. Summers,et al.  Noise Trader Risk in Financial Markets , 1990, Journal of Political Economy.

[18]  L. Summers,et al.  The Noise Trader Approach to Finance , 1990 .

[19]  John Y. Campbell,et al.  No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns , 1991 .

[20]  Jeremy C. Stein,et al.  Transactional Risk, Market Crashes, and the Role of Circuit Breakers , 1991 .

[21]  Daniel B. Nelson.  CONDITIONAL HETEROSKEDASTICITY IN ASSET RETURNS: A NEW APPROACH , 1991 .

[22]  D. Romer.  Rational Asset Price Movements Without News , 1992 .

[23]  Charles J. Jacklin,et al.  Underestimation of Portfolio Insurance and the Crash of October 1987 , 1992 .

[24]  L. Glosten,et al.  On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks , 1993 .

[25]  M. Harris,et al.  Differences of Opinion Make a Horse Race , 1993 .

[26]  Andrew Caplin,et al.  Business as Usual, Market Crashes, and Wisdom after the Fact , 1994 .

[27]  Daniel B. Nelson,et al.  Good News, Bad News, Volatility, and Betas , 1995 .

[28]  G. Duffee,et al.  Stock returns and volatility A firm-level analysis , 1995 .

[29]  Neil D. Pearson,et al.  Differential Interpretation of Public Signals and Trade in Speculative Markets , 1995, Journal of Political Economy.

[30]  Allan W. Kleidon,et al.  Chapter 16 Stock market crashes , 1995, Finance.

[31]  Jeff Fleming,et al.  Implied volatility functions: empirical tests , 1996, IEEE/IAFE 1996 Conference on Computational Intelligence for Financial Engineering (CIFEr).

[32]  Guojun Wu,et al.  Asymmetric Volatility and Risk in Equity Markets , 1997 .

[33]  Gurdip Bakshi,et al.  Empirical Performance of Alternative Option Pricing Models , 1997 .

[34]  J. Stein,et al.  A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets , 1997 .

[35]  Terrance Odean,et al.  Volume, Volatility, Price, and Profit When All Traders are Above Average , 1998 .

[36]  Matthew Pritsker,et al.  A Rational Expectations Model of Financial Contagion , 1998 .

[37]  Jeffrey Pontiff,et al.  How Are Derivatives Used? Evidence from the Mutual Fund Industry , 1999 .

[38]  David S. Bates.  Post-'87 crash fears in the S&P 500 futures option market , 2000 .

[39]  Guojun Wu,et al.  The Determinants of Asymmetric Volatility , 2001 .

[40]  G. Duffee.  Asymmetric cross-sectional dispersion in stock returns: evidence and implications , 2001 .

[41]  Joseph Chen,et al.  Breadth of Ownership and Stock Returns , 2001 .

[42]  D. Hirshleifer,et al.  Sidelined Investors, Trading-Generated News, and Security Returns , 2001 .

[43]  Patrick J. Dennis,et al.  Risk-Neutral Skewness: Evidence from Stock Options , 2002 .

[44]  David A. Chapman,et al.  Why Constrain Your Mutual Fund Manager? , 2002 .

[45]  Adam V. Reed,et al.  Stocks are Special Too: An Analysis of the Equity Lending Market , 2002 .

[46]  Christopher J. Malloy,et al.  Differences of Opinion and the Cross Section of Stock Returns , 2002 .

[47]  Short Sale Constraints and Stock Returns , 2002 .

[48]  G. D'Avolio,et al.  The Market for Borrowing Stock , 2002 .

[49]  David A. Chapman,et al.  Why constrain your mutual fund manager , 2004 .

[50]  May,et al.  Stock market crashes , 2004 .

[51]  The,et al.  DIFFERENCES OF OPINION IN FINANCIAL MARKETS , 2022 .