A probit-based analysis of the deep stock market drawdowns

Abstract

Purpose

This study is motivated in part by the fact that the unfolding 2022 bear market, which has reached the −25% drawdown, has not been preceded by the inverted 10Y-3 m spread or an inverted near-term forward spread.

Design/methodology/approach

The authors develop a three-factor probit model to predict/explain the deep stock market drawdowns, which the authors define as the drawdowns in excess of 20%.

Findings

The study results show that (1) the rising credit risk predicts a deep drawdown about a year in advance and (2) the monetary policy easing precedes an imminent drawdown below the 20% threshold.

Originality/value

This study three-factor probit model shows adaptability beyond the typical recessionary bear market and predicts/explains the liquidity-based selloffs, like the 2022 and possibly the 1987 deep drawdowns.

Citation

Tokic, D. and Jackson, D. (2024), "A probit-based analysis of the deep stock market drawdowns", Journal of Economic Studies, Vol. 51 No. 5, pp. 993-1010. https://doi.org/10.1108/JES-05-2023-0228