Testing market responses under extreme risks

Voluminous studies have demonstrated theoretically and empirically that psychology plays a very important role in investor's trading behaviors. However, studies investigating market response to extreme risks are still inaccessible to our knowledge. This paper provides a statistical method to testify market response to extreme risks based on value at risk. Empirical results performed on US Dow Jones Industrial Average index demonstrate the market irrational response to extreme risk: at long-horizons, the market tends to rebound if a large drop happens; however, momentum is more possible in market response at either short- or long-horizon if a sharp rise takes place.