TY  - JOUR
AU  - Hong,Harrison
AU  - Stein,Jeremy C.
TI  - Differences of Opinion, Rational Arbitrage and Market Crashes
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7376
PY  - 1999
Y2  - October 1999
UR  - http://www.nber.org/papers/w7376
L1  - http://www.nber.org/papers/w7376.pdf
N1  - Author contact info:
Harrison Hong
Department of Economics
Princeton University
26 Prospect Avenue
Princeton, NJ 08540
Tel: 609/258-0259
Fax: 609/258-0771
E-Mail: hhong@princeton.edu

Jeremy C. Stein
Federal Reserve Board of Governors
20th Street and Constitution Ave., N.W.
Washington, DC 20551
E-Mail: jeremy.c.stein@frb.gov
AB  - We develop a theory of stock-market crashes based on differences of opinion among investors. Because of short-sales constraints, bearish investors do not initially participate in the market and their information is not revealed in prices. However, if other, previously-bullish investors have a change of heart and bail out of market, the originally-more-bearish group may become the marginal "support buyers", and hence more will be learned about their signals. Thus accumulated hidden information tends to come out during market declines. The model helps explain a variety of stylized facts, including: 1) large movements in prices unaccompanied by significant news about fundamentals; 2) negative skewness in the distribution of market returns; and 3) increased correlation among stocks in a falling market.  In addition, the model makes a distinctive out-of-sample prediction: that negative skewness will be most pronounced conditional on high trading volume.
ER  -