Professor helps develop system that warns of stock crashes

A professor in the Berkeley-Haas School of Business’s accounting group has helped devise a “crash flag” system to help investors avoid stock price crashes.

Richard Sloan and co-authors Korcan Ak, a Berkeley-Haas Ph.D. candidate, analyst Steve Rossi of RS Investment and portfolio manager Scott Trac, say their work should help investors to build equity portfolios with fewer stock price crashes, higher returns and lower volatility.

A new Berkeley-Haas study looks at navigating stock price crashes. (iStock image.)

A new Berkeley-Haas study looks at navigating stock price crashes. (iStock image)

The researchers identify five variables helpful in predicting price crashes for individual stocks in their paper “Navigating Stock Price Crashes,” published via the Social Science Research Network. The variables include:

• Unusual trading volume.
• High short interest, which is measured in terms of shares sold short as a percentage of shares outstanding or a percentage of float, the total number of shares available to trade.
• Large accounting accruals.
• Extreme valuations.
• High growth expectations.

“We’re not necessarily advocating that investors should trade stocks based on crash risk flags alone,” says Sloan. But he and his fellow researchers found that stocks ranking in the top 20 percent on at least three of these markers were found significantly more likely to undergo a price crash during the next six months.

For more details, read the full story in Berkeley-Haas Research News.