How Crashes Develop: Intradaily Volatility and Crash Evolution
This paper explores whether affine models with volatility jumps estimated on intradaily S&P 500 futures data over 1983-2008 can capture major daily outliers such as the 1987 stock market crash. I find that intradaily jumps in futures prices are typically small, and that self-exciting but short-lived volatility spikes capture intradaily and daily returns better. Multifactor models of the evolution of diffusive variance and jump intensities improve fits substantially, including out-of-sample over 2009-13. The models capture reasonably well the conditional distributions of daily returns and of realized variance outliers, but underpredict realized variance inliers.
I am grateful for comments on earlier versions of the paper from seminar participants at Iowa, Northwestern, Houston, and Lugano, and from conference participants at the 2012 IFSID Conference on Structured Products and Derivatives and McGill University’s 2014 Risk Management Conference. The University of Iowa provided research support for this project. There were no relevant nor material external financial relationships that could have influenced this research. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.