Related papers: Leverage Causes Fat Tails and Clustered Volatility
Risk and uncertainty will always be a matter of experience, luck, skills, and modelling. Leverage is another concept, which is critical for the investor decisions and results. Adaptive skills and quantitative probabilistic methods need to…
It is widely believed that fluctuations in transaction volume, as reflected in the number of transactions and to a lesser extent their size, are the main cause of clustered volatility. Under this view bursts of rapid or slow price diffusion…
When trading incurs proportional costs, leverage can scale an asset's return only up to a maximum multiple, which is sensitive to its volatility and liquidity. In a model with one safe and one risky asset, with constant investment…
We propose a random walk model of asset returns where the parameters depend on market stress. Stress is measured by, e.g., the value of an implied volatility index. We show that model parameters including standard deviations and…
In retrospect, the experimental findings on competitive market behavior called for a revival of the old, classical, view of competition as a collective higgling and bargaining process (as opposed to price-taking behaviors) founded on…
Excessive leverage, i.e. the abuse of debt financing, is considered one of the primary factors in the default of financial institutions. Systemic risk results from correlations between individual default probabilities that cannot be…
Financial price changes obey two universal properties: they follow a power law and they tend to be clustered in time. The second regularity, known as volatility clustering, entails some predictability in the price changes: while their sign…
We present a simple agent-based model of a financial system composed of leveraged investors such as banks that invest in stocks and manage their risk using a Value-at-Risk constraint, based on historical observations of asset prices. The…
Systemic financial risk refers to the simultaneous failure or destabilization of multiple financial institutions, often triggered by contagion mechanisms or common exposures to shocks. In this paper, we present a dynamical model of bank…
In the world of modern financial theory, portfolio construction has traditionally operated under at least one of two central assumptions: the constraints are derived from a utility function and/or the multivariate probability distribution…
Fat tails in financial time series and increase of stocks cross-correlations in high volatility periods are puzzling facts that ask for new paradigms. Both points are of key importance in fundamental research as well as in Risk Management…
Financial volatility obeys two fascinating empirical regularities that apply to various assets, on various markets, and on various time scales: it is fat-tailed (more precisely power-law distributed) and it tends to be clustered in time.…
It is well known that the distribution of returns from various financial instruments are leptokurtic, meaning that the distributions have "fatter tails" than a Normal distribution, and have skew toward zero. This paper presents a graceful…
We show that typical behaviors of market participants at the high frequency scale generate leverage effect and rough volatility. To do so, we build a simple microscopic model for the price of an asset based on Hawkes processes. We encode in…
A classic problem in physics is the origin of fat tailed distributions generated by complex systems. We study the distributions of stock returns measured over different time lags $\tau.$ We find that destroying all correlations without…
An analysis of the stylized facts in financial time series is carried out. We find that, instead of the heavy tails in asset return distributions, the slow decay behaviour in autocorrelation functions of absolute returns is actually…
Power-law tails are ubiquitous in income distributions and in the energy distributions of diluted relativistic gases. We analyze the conceptual link between these two cases. In economic interactions fat tails arise because the richest…
It is common knowledge that leverage can increase the potential returns of an investment, at the expense of increased risk. For a passive investor in the stock market, leverage can be achieved using margin debt or leveraged-ETFs. We perform…
The practice of valuation by marking-to-market with current trading prices is seriously flawed. Under leverage the problem is particularly dramatic: due to the concave form of market impact, selling always initially causes the expected…
Financial time series exhibit a number of interesting properties that are difficult to explain with simple models. These properties include fat-tails in the distribution of price fluctuations (or returns) that are slowly removed at longer…