Research-Circuit Breakers and Financial Contagion

Research

Financial Math Seminar

Circuit Breakers and Financial Contagion

Speaker: Xudong Zeng (Shanghai University of Finance and Economics)
Time: Nov 25, 2021, 17:00-18:00
Location: Lecture Room 415, Block 3, Hui Yuan

Abstract

Circuit breakers based on indices are commonly imposed in financial markets to reduce market crashes and volatility in bad times. We develop a dynamic equilibrium model with multiple stocks to study how circuit breakers affect joint stock price dynamics and cross-stock contagion. We show that circuit breakers can cause crash contagion, volatility contagion, and high correlations among otherwise independent stocks, especially in bad times. Our analysis suggests that circuit breakers rules might have exacerbated the market plunges and extreme volatility triggered by the COVID-19 pandemic. We propose an alternative circuit breaker approach that does not cause cross-stock contagion.