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Anatomy of a meltdown: The risk neutral density for the S&P 500 in the fall of 2008

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  • Birru, Justin
  • Figlewski, Stephen

Abstract

We examine the risk neutral probability density (RND) for the S&P 500 extracted from real-time bid and ask quotes for index options, under extreme market stress during the fall of 2008. The RND provides exceptional detail about investors' expectations as intraday volatility increased to a level five times higher than it had been two years earlier. Arbitrage keeps the mean of the RND closely tied to the market index, but its autocorrelation is very different. We also find a strong pattern in the RND's response to stock index movements: The middle portion amplifies the index change by more than 50% in some cases. This overshooting increased during the crisis and, surprisingly, was stronger in up moves than down moves.

Suggested Citation

  • Birru, Justin & Figlewski, Stephen, 2012. "Anatomy of a meltdown: The risk neutral density for the S&P 500 in the fall of 2008," Journal of Financial Markets, Elsevier, vol. 15(2), pages 151-180.
    • Handle: RePEc:eee:finmar:v:15:y:2012:i:2:p:151-180
    DOI: 10.1016/j.finmar.2011.09.001
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    More about this item

    Keywords

    Risk neutral density; Implied probabilities; Stock index options; 2008 financial crisis;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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