Leverage Effect Breakdowns & Flight from Risky Assets

Though part of “market lore,” Black (1976) first reported the inverse relationship between price and volatility, calling it the “leverage effect.” Without providing evidence, Black (1988) claims that in the months leading up to the October ‘87 Crash the relationship changed: price and volatility both rose. Using daily data for the Old VIX, derived from S&P 100 Index option market prices, to estimate intra-quarterly regressions of implied volatility against price from Q2 1986 – Q1 2012, I can verify Black's claim for the October '87 Crash, and interestingly, for subsequent periods of crisis. I then analyze several Constant Elasticity of Variance optimal portfolio rules, which include the leverage effect, to show the elasticity sign switch implies that investors reduce their risky asset holdings to zero