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Full-Text Articles in Social and Behavioral Sciences
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
A recent literature shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility, that is, it assumes an inverse relationship between first and second moments of asset returns. This paper suggests a reason why bad news is more often than not associated with higher future volatility. We show that, in a model with endogenous leverage and heterogeneous beliefs, agents have the incentive to invest mostly in technologies that become more volatile in bad times. Agents choose these technologies because they can be leveraged more during normal times. Together …
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
The literature on leverage until now shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility. This paper suggests a reason why bad news is more often than not associated with higher future volatility. We show that, in a model with endogenous leverage and heterogeneous beliefs, agents have the incentive to invest mostly in technologies that become volatile in bad times. Together with the old literature this explains pro-cyclical leverage. The result also gives rationale to the pattern of volatility smiles observed in the stock options since 1987. …
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Why Does Bad News Increase Volatility And Decrease Leverage?, Ana Fostel, John Geanakoplos
Cowles Foundation Discussion Papers
A recent literature shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility, that is, it assumes an inverse relationship between first and second moments of asset returns. This paper suggests a reason why bad news is more often than not associated with higher future volatility. We show that, in a model with endogenous leverage and heterogeneous beliefs, agents have the incentive to invest mostly in technologies that become more volatile in bad times. Agents choose these technologies because they can be leveraged more during normal times. Together …