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The market for crash risk. (English) Zbl 1181.91223
Summary: This paper examines the equilibrium when stock market crashes can occur and investors have heterogeneous attitudes towards crash risk. The less crash averse insure the more crash averse through options markets that dynamically complete the economy. The resulting equilibrium is compared with various option pricing anomalies: the tendency of stock index options to overpredict volatility and jump risk, the J. C. Jackwerth and M. Rubinstein [“Recovering risk aversion from option prices and realized returns”, Rev. Financ. Stud. 13, 433–451 (1996)] implicit pricing kernel puzzle, and the stochastic evolution of option prices. Crash aversion is compatible with some static option pricing puzzles, while heterogeneity partially explains dynamic puzzles. Heterogeneity also magnifies substantially the stock market impact of adverse news about fundamentals.
MSC:
91B69Heterogeneous agent models in economics
91G20Derivative securities
91B25Asset pricing models
91B30Risk theory, insurance
91G99Mathematical finance
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