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Circuit Breakers and the Tail Index of Equity Returns

Author

Listed:
  • John W. Galbraith
  • Serguei Zernov
Abstract
Using the tail index of returns on US equities as a summary measure of extreme behaviour, we examine changes in the equity markets surrounding the development of program trading for portfolio insurance, the crash of 1987, and the subsequent introduction of circuit breakers and other changes in market architecture. Recently-developed tests for the null of constancy of the tail index, versus the alternative of a change at an unknown date, permit inference on changes in extreme behaviour over a long time period while allowing for second-moment dependence in the return data. We find strong evidence of a decrease in the tail index (increase in the probability of extreme events) around the beginning of large scale program trading, and weaker, but still substantial, evidence of further significant change in the tail index following the introduction of circuit breakers. Point estimates of the tail index suggest that the tail index has nonetheless not regained pre-program-trading levels. Utilisant l'indice de queue de distribution (index tail) des rendements financiers sur actions dans les marchés américains comme mesure sommaire des comportements extrêmes, nous examinons les changements dans le marché des actions entourant le développement de programmes automatiques de transaction (Trading Program) pour l'assurance de portefeuille, le krach de 1987, l'introduction des coupe-circuits et autres changements dans les systèmes financiers. De nouveaux tests, récemment développés, permettent l'inférence statistique sur le changement des comportements extrêmes sur une longue période ; tests qui sont valides dans le cas d'hétéroscédasticité conditionnelle. L'hypothèse nulle est que l'indice de queue de distribution est constant alors que l'hypothèse alternative est le changement de cet indice à une date inconnue. Nous avons trouvé de manière très significative que d'une part, l'indice de queue de distribution a diminué (la probabilité d'évènements extrêmes a augmenté) au début de la période des programmes de transactions. D'autre part, l'introduction de coupe-circuits a augmenté cet indice mais est resté plus faible que sa valeur avant l'introduction des programmes de transactions. Les estimateurs de l'indice de queue de distribution suggèrent qu'il n'a pas retrouvé sa valeur initiale.

Suggested Citation

  • John W. Galbraith & Serguei Zernov, 2002. "Circuit Breakers and the Tail Index of Equity Returns," CIRANO Working Papers 2002s-62, CIRANO.
  • Handle: RePEc:cir:cirwor:2002s-62
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    File URL: https://cirano.qc.ca/files/publications/2002s-62.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. Lee, Chien-Chiang & Chiu, Yi-Bin, 2016. "Globalization and insurance activity: Evidence on the industrial and emerging countries," The North American Journal of Economics and Finance, Elsevier, vol. 36(C), pages 328-349.
    2. Bryan Kelly & Hao Jiang, 2013. "Tail Risk and Asset Prices," NBER Working Papers 19375, National Bureau of Economic Research, Inc.
    3. Chen, Zhimin & Ibragimov, Rustam, 2019. "One country, two systems? The heavy-tailedness of Chinese A- and H- share markets," Emerging Markets Review, Elsevier, vol. 38(C), pages 115-141.
    4. Fendel, Ralf & Neumann, Christian, 2021. "Tail risk in the European sovereign bond market during the financial crises: Detecting the influence of the European Central Bank," Global Finance Journal, Elsevier, vol. 50(C).
    5. Daniele Massacci, 2017. "Tail Risk Dynamics in Stock Returns: Links to the Macroeconomy and Global Markets Connectedness," Management Science, INFORMS, vol. 63(9), pages 3072-3089, September.
    6. Wu, Ying, 2019. "Asset pricing with extreme liquidity risk," Journal of Empirical Finance, Elsevier, vol. 54(C), pages 143-165.
    7. Straetmans, Stefan & Candelon, Bertrand, 2013. "Long-term asset tail risks in developed and emerging markets," Journal of Banking & Finance, Elsevier, vol. 37(6), pages 1832-1844.
    8. Ayala Astrid & Blazsek Szabolcs & Escribano Alvaro, 2023. "Anticipating extreme losses using score-driven shape filters," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 27(4), pages 449-484, September.
    9. Ayala, Astrid & Blazsek, Szabolcs, 2019. "Score-driven time series models with dynamic shape : an application to the Standard & Poor's 500 index," UC3M Working papers. Economics 28133, Universidad Carlos III de Madrid. Departamento de Economía.
    10. Ayala, Astrid & Blazsek, Szabolcs, 2017. "Dynamic conditional score models with time-varying location, scale and shape parameters," UC3M Working papers. Economics 25043, Universidad Carlos III de Madrid. Departamento de Economía.
    11. Wagner, Niklas, 2005. "Autoregressive conditional tail behavior and results on Government bond yield spreads," International Review of Financial Analysis, Elsevier, vol. 14(2), pages 247-261.
    12. Palumbo, D., 2021. "Testing and Modelling Time Series with Time Varying Tails," Cambridge Working Papers in Economics 2111, Faculty of Economics, University of Cambridge.
    13. Bollerslev, Tim & Todorov, Viktor, 2014. "Time-varying jump tails," Journal of Econometrics, Elsevier, vol. 183(2), pages 168-180.
    14. Riedel, Christoph & Wagner, Niklas, 2015. "Is risk higher during non-trading periods? The risk trade-off for intraday versus overnight market returns," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 39(C), pages 53-64.
    15. John G. Galbraith & Serguei Zernov, 2006. "Extreme Dependence In The Nasdaq And S&P Composite Indexes," Departmental Working Papers 2006-14, McGill University, Department of Economics.
    16. Ayala, Astrid & Blazsek, Szabolcs, 2019. "Maximum likelihood estimation of score-driven models with dynamic shape parameters : an application to Monte Carlo value-at-risk," UC3M Working papers. Economics 28638, Universidad Carlos III de Madrid. Departamento de Economía.
    17. John Galbraith & Serguei Zernov, 2009. "Extreme dependence in the NASDAQ and S&P 500 composite indexes," Applied Financial Economics, Taylor & Francis Journals, vol. 19(13), pages 1019-1028.

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    More about this item

    Keywords

    Circuit breaker; structural change tests; tail index; Coupe-circuits; tests sur le changement structurel; indice de queue de distribution;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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