Leverage effect breakdowns and flight from risky assets

Though part of market lore , in 1976 Black first reported the inverse relationship between price and volatility, calling it the leverage effect . Without providing evidence, in 1988 Black claimed that in the months leading up to the October 1987 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 to Q1 2012, the author verifies Black s claim for the October 1987 crash, and interestingly, for subsequent periods of crisis. He then analyses 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.