Market Jumps: Causes and Investor Reactions

• Applicant: Professor Dr. Fabian Hollstein
• Subject Area: Accounting and Finance ; Statistics and Econometrics
• Term: since 2024
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 542548804

This project aims to investigate the causes of, and investor reactions to, market-wide jumps. In addition, important news announcements that may cause jumps are used to link asset prices and the macroeconomy. The previous literature has limited success in linking stock price jumps to scheduled and unscheduled news. Therefore, we first propose and analyze liquidity as an important driver of stock market jumps. We thoroughly analyze the role of liquidity by comparing economically perfectly similar instruments that differ only in their liquidity. That is, we use high-frequency data to analyze the jump arrival times and distributions of different futures contracts on the S&P 500 stock market index. On this basis, we decompose the jump risk premium and isolate the impact of liquidity. This research offers two clear advances over the previous literature in that (i) we can cleanly analyze the effect of liquidity on both the size and the timing of the jump while (ii) controlling for the information set. Second, little is known in the literature about how market participants trade around jump events. Therefore, we use the identified jumps in the stock market and the volatility index to analyze the behavior of investors around these important events. To do so, we use high-frequency open/close trade profile data on options on the S&P 500 to study the trading of different market participants, e.g., market makers and retail and institutional investors. We analyze the order imbalance of these different types of traders before and after the jump to examine which types of traders anticipate jumps, in which direction they trade afterwards, and who the liquidity providers and takers are. We also use several time-series variables related to investors' risk perception, sentiment, and funding constraints to explain the dynamics of order imbalances and inventories around jump observations. Finally, we link news-based drivers of jumps to asset prices. Little is known in the literature about the impact of macroeconomic announcements on the cross-section of stock returns. We contribute to the literature by examining intraday announcement betas for different types of macroeconomic announcements. This allows us to cleanly separate the announcement effects from the ordinary price variation, identify the risk premia associated with each macroeconomic series, and compare their relative importance. We use the entire cross-section of U.S. stock returns and a broad set of macroeconomic announcements. Using the announcement betas and several control variables, we compute the macroeconomic announcement risk premia using Fama & MacBeth (1973) regressions.

• DFG Programme: Research Grants
• International Connection: United Kingdom
• Cooperation Partner: Professor Dr. Chardin Wese Simen