Failing to forecast rare events

Bond, P and Dow, J (2021) Failing to forecast rare events. Journal of Financial Economics, 142 (3). pp. 1001-1016. ISSN 0304-405X OPEN ACCESS


Do more talented traders prefer to bet on and against rare events or common events? Bets on rare events include out of the money options. Bets against rare events include the carry trade and investment grade bonds. In a model where traders specialize, equilibrium pricing reflects trading ability: A market with more skilled traders has a larger bid ask spread. We show that lower skill traders bet on and against rare events, while higher skill traders bet on and against frequent events, leading to higher bid-ask spreads in common event assets, and reducing financial markets’ ability to predict rare events.

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Item Type: Article
Subject Areas: Finance
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© 2021 Elsevier

Date Deposited: 12 Mar 2021 17:01
Date of first compliant deposit: 12 Mar 2021
Subjects: Market forecasting
Financial markets
Financial risk
Last Modified: 20 Jul 2024 01:55

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