Leverage causes fat tails and clustered volatility
@article{Thurner2009LeverageCF, title={Leverage causes fat tails and clustered volatility}, author={Stefan Thurner and J. Doyne Farmer and John Geanakoplos}, journal={Quantitative Finance}, year={2009}, volume={12}, pages={695 - 707} }
We build a simple model of leveraged asset purchases with margin calls. Investment funds use what is perhaps the most basic financial strategy, called ‘value investing’, i.e. systematically attempting to buy underpriced assets. When funds do not borrow, the price fluctuations of the asset are approximately normally distributed and uncorrelated across time. This changes when the funds are allowed to leverage, i.e. borrow from a bank, which allows them to purchase more assets than their wealth…
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