Hi guys, just saw this a few minutes ago and am not quite sure if it still works this way. <i> Portfolio insurance may be an example of a stragety that attempts to precommit to withdraw funds in the case of large moves, which will thus worsen the liquididy (pressure) effects... Leland and Rubinstein (1988) describe some possible front-running in October of 1987: "with the sudden fall in the market during the last half hour of trading on October 16, many insurers found themselves with an overhang of unfilled sell orders going into Monday. In addition, several smart institutional traders knew about this overhang and tried to exit the market early Monday before the insurers could complete their trades."</i> My question is, does anyone know if such porftolio insurance effects are still there given a large move in price? Does anyone have any industry knowledge of whether the practice is still in use? TIA.
this is also somewhat related to the prior question... if someone has a large position and the stock declines drastically on any given day, way below the maintenance margin, at what point in time will the brokerage close their clients positions? Will it be next day or on the day of the drop? The reason I'm asking is b/c I'm trying to see how this can be placed in the context of feedback trading and overreaction/liquidity pressure leading to subsequent reversals.
Although I do not know if portfolio insurance is still prevalent, I do believe that the trading curbs that are declared after a large down movement are intended to prevent a repeat of Oct 87 by prohibiting program trading. Whether institutions adhere to those curbs or whether the existence of curbs destroyed the viability of portfolio insurance is another issue. But on the topic of self-amplifying downward moves, I wonder about the impact of the "cut your losses short" meme. If (and a big if it is) everyone followed this popular adage, downward movements would be quite severe. Maybe the much maligned human tendency toward loss aversion helps stabilize the markets during the down days. For example, when THC lost nearly half its value on Nov 8th, less than 1/4 of the float traded that day. Thus, at least 75% of the shareholders held despite the massive loss (which compounded earlier large losses the previous week). Had every shareholder used the recommended 2% stop-loss rule, the downdraft would have been far more severe. Cheers and great fund management to you, Traden4Alpha
Interesting points, T4A. I've seen some studies that show the imposed trading halts actually increase the volatility afterwards, totally contrary to what they are meant to do. I think you are right on the cut your losses short point. There's a recent paper (I think it's still in the working paper stage) by Barber and Odean that shows that when a stock moves down substantially, the small investors serve as a buffer as they buy when large institutions are getting out. They claim that it's this trading by small investors that contributes to short term momentum, b/c they slow down the adjustment... I think I have the paper if you wanna take a look at it. I also have another one with a theoretical model of liquidity runs that is related to the issue you raised above. I tried to attach it but it's too big... Thanks, it's been really slow the last couple of weeks, now that the reporting season is over... Looking forward to those preannouncement warnings... Good trading to you too.
Hey, nice usage, t4a; kudos. "I do not know if portfolio insurance is still prevalent" IIRC, it's a "large" factor in SP500 options volume, from institutions.