Arbeitspapier

Realizing stock market crashes: Stochastic cusp catastrophe model of returns under the time-varying volatility

This paper develops a two-step estimation methodology, which allows us to apply catastrophe theory to stock market returns with time-varying volatility and model stock market crashes. Utilizing high frequency data, we estimate the daily realized volatility from the returns in the first step and use stochastic cusp catastrophe on data normalized by the estimated volatility in the second step to study possible discontinuities in markets. We support our methodology by simulations where we also discuss the importance of stochastic noise and volatility in deterministic cusp catastrophe model. The methodology is empirically tested on almost 27 years of U.S. stock market evolution covering several important recessions and crisis periods. Due to the very long sample period we also develop a rolling estimation approach and we find that while in the first half of the period stock markets showed marks of bifurcations, in the second half catastrophe theory was not able to confirm this behavior. Results suggest that the proposed methodology provides an important shift in application of catastrophe theory to stock markets.

Language
Englisch

Bibliographic citation
Series: IES Working Paper ; No. 19/2013

Classification
Wirtschaft
Econometrics
Forecasting Models; Simulation Methods
Subject
stochastic cusp catastrophe model
realized volatility
bifurcations
stock market crash

Event
Geistige Schöpfung
(who)
Baruník, Jozef
Kukačka, Jiří
Event
Veröffentlichung
(who)
Charles University in Prague, Institute of Economic Studies (IES)
(where)
Prague
(when)
2013

Handle
Last update
10.03.2025, 11:46 AM CET

Data provider

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Object type

  • Arbeitspapier

Associated

  • Baruník, Jozef
  • Kukačka, Jiří
  • Charles University in Prague, Institute of Economic Studies (IES)

Time of origin

  • 2013

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