Underestimation of Portfolio Insurance and the Crash of October 1987
- 1 January 1992
- journal article
- research article
- Published by Oxford University Press (OUP) in The Review of Financial Studies
- Vol. 5 (1) , 35-63
- https://doi.org/10.1093/rfs/5.1.35
Abstract
We examine market crashes in the multiperiod framework of Glosten and Milgrom (1985). Our analysis shows that if the market’s prior beliefs underestimate the extent of dynamic bedging strategies such as portfolio insurance, then the price will be greater than that which would be implied by fundamentals if the extent of portfolio insurance were known with certainty. Over time, the market learns of the amount of portfolio insurance, and consequently reevaluates the previous inferences drawn from purchases that were erroneously regarded as based on favorable information. The result is that the price falls when the amount of portfolio insurance is revealed.Keywords
This publication has 12 references indexed in Scilit:
- Order Form and Information in Securities MarketsThe Journal of Finance, 1991
- Liquidity and the 1987 stock market crashThe Journal of Portfolio Management, 1990
- On Technical AnalysisThe Review of Financial Studies, 1989
- Trade and the Revelation of Information through Prices and Direct DisclosureThe Review of Financial Studies, 1989
- Triggering the 1987 stock market crashJournal of Financial Economics, 1989
- Portfolio Insurance and Financial Market EquilibriumThe Journal of Business, 1989
- The International Crash of October 1987CFA Magazine, 1988
- An Equilibrium Model of the CrashNBER Macroeconomics Annual, 1988
- An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging StrategiesThe Journal of Business, 1988
- Bid, ask and transaction prices in a specialist market with heterogeneously informed tradersJournal of Financial Economics, 1985