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Equity Price Dynamics Under Shocks: In Distress or Short Squeeze
Version 1
: Received: 8 November 2023 / Approved: 8 November 2023 / Online: 8 November 2023 (05:04:52 CET)
A peer-reviewed article of this Preprint also exists.
Hui, C.-H.; Lo, C.-F.; Liu, C.-H. Equity Price Dynamics under Shocks: In Distress or Short Squeeze. Risks 2024, 12, 1. Hui, C.-H.; Lo, C.-F.; Liu, C.-H. Equity Price Dynamics under Shocks: In Distress or Short Squeeze. Risks 2024, 12, 1.
Abstract
A simple bounded stochastic motion is employed for modelling equity price dynamics under shocks, where the prices are constrained to lie between two positive bounds. While the stochastic process has an inaccessible boundary, the other boundary is quasi-bounded, implying that the boundary can be breached if the probability leakage condition is met. The quasi-boundedness of the process at the boundary can thus provide an indicator of possible risk of equities under price shocks. Empirical calibration of model parameters of the proposed process for equities can be performed easily due to the availability of an analytically tractable probability density function which generates fat-tailed distributions consistent with empirical observations. The volatility and mean-reversion of the S&P500 dynamics calibrated by the process is positively and negatively co-integrated respectively with the VIX index representing the level of market distress. The process captures the high likelihood of Hertz’s default about two months earlier, using only information until that point, and before the firm filed for Chapter 11 bankruptcy in May 2020 as a result of the Covid-19 pandemic. Empirical calibration of the process for GameStop’s stock price shows that the short squeeze of the stock occurred when the condition for breaching an upper boundary was met on 14 January 2021, i.e., about two weeks before major short sellers closed out their positions with significant losses. The trading volume of the stock was positively co-integrated with the probability leakage ratio.
Keywords
financial risk; market distress; predatory trading; short squeeze; constrained stochastic motion; quasi-bounded process; Covid-19
Subject
Business, Economics and Management, Finance
Copyright: This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
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