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Bubble diagnosis and prediction of the 2005-2007 and 2008-2009 Chinese stock market bubbles

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Author Info

  • Jiang, Zhi-Qiang
  • Zhou, Wei-Xing
  • Sornette, Didier
  • Woodard, Ryan
  • Bastiaensen, Ken
  • Cauwels, Peter
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    Abstract

    By combining (i) the economic theory of rational expectation bubbles, (ii) behavioral finance on imitation and herding of investors and traders and (iii) the mathematical and statistical physics of bifurcations and phase transitions, the log-periodic power law (LPPL) model has been developed as a flexible tool to detect bubbles. The LPPL model considers the faster-than-exponential (power law with finite-time singularity) increase in asset prices decorated by accelerating oscillations as the main diagnostic of bubbles. It embodies a positive feedback loop of higher return anticipations competing with negative feedback spirals of crash expectations. We use the LPPL model in one of its incarnations to analyze two bubbles and subsequent market crashes in two important indexes in the Chinese stock markets between May 2005 and July 2009. Both the Shanghai stock exchange composite index (US ticker symbol SSEC) and Shenzhen stock exchange component index (SZSC) exhibited such behavior in two distinct time periods: (1) from mid-2005, bursting in October 2007 and (2) from November 2008, bursting in the beginning of August 2009. We successfully predicted time windows for both crashes in advance (Sornette, 2007; Bastiaensen et al., 2009) with the same methods used to successfully predict the peak in mid-2006 of the US housing bubble (Zhou and Sornette, 2006b) and the peak in July 2008 of the global oil bubble (Sornette et al., 2009). The more recent bubble in the Chinese indexes was detected and its end or change of regime was predicted independently by two groups with similar results, showing that the model has been well-documented and can be replicated by industrial practitioners. Here we present a more detailed analysis of the individual Chinese index predictions and of the methods used to make and test them. We complement the detection of log-periodic behavior with Lomb spectral analysis of detrended residuals and (H,q)-derivative of logarithmic indexes for both bubbles. We perform unit-root tests on the residuals from the log-periodic power law model to confirm the Ornstein-Uhlenbeck property of bounded residuals, in agreement with the consistent model of 'explosive' financial bubbles (Lin et al., 2009).

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Behavior & Organization.

    Volume (Year): 74 (2010)
    Issue (Month): 3 (June)
    Pages: 149-162

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    Handle: RePEc:eee:jeborg:v:74:y:2010:i:3:p:149-162

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    Web page: http://www.elsevier.com/locate/jebo

    Related research

    Keywords: Stock market crash Financial bubble Chinese markets Rational expectation bubble Herding Log-periodic power law Lomb spectral analysis Unit-root test;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Anders Johansen & Didier Sornette, 1999. "Critical Crashes," Papers cond-mat/9901035, arXiv.org.
    2. K. Bastiaensen & P. Cauwels & D. Sornette & R. Woodard & W. -X. Zhou, 2009. "The Chinese Equity Bubble: Ready to Burst," Papers 0907.1827, arXiv.org.
    3. J. Barkley Rosser, 2008. "Econophysics And Economic Complexity," Advances in Complex Systems (ACS), World Scientific Publishing Co. Pte. Ltd., vol. 11(05), pages 745-760.
    4. Sornette, Didier & Woodard, Ryan & Zhou, Wei-Xing, 2009. "The 2006–2008 oil bubble: Evidence of speculation, and prediction," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 388(8), pages 1571-1576.
    5. Zhou, Wei-Xing & Sornette, Didier, 2009. "Numerical investigations of discrete scale invariance in fractals and multifractal measures," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 388(13), pages 2623-2639.
    6. Ide, Kayo & Sornette, Didier, 2002. "Oscillatory finite-time singularities in finance, population and rupture," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 307(1), pages 63-106.
    7. Lux, T. & M. Marchesi, . "Scaling and Criticality in a Stochastic Multi-Agent Model of a Financial Market," Discussion Paper Serie B 438, University of Bonn, Germany, revised Jul 1998.
    8. Zhou, Wei-Xing & Jiang, Zhi-Qiang & Sornette, Didier, 2007. "Exploring self-similarity of complex cellular networks: The edge-covering method with simulated annealing and log-periodic sampling," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 375(2), pages 741-752.
    9. Zhou, Wei-Xing & Sornette, Didier, 2006. "Is there a real-estate bubble in the US?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 361(1), pages 297-308.
    10. Refet Gurkaynak, 2005. "Econometric Tests of Asset Price Bubbles: Taking Stock," Finance 0504008, EconWPA.
    11. D. Sornette, 2003. "Critical Market Crashes," Papers cond-mat/0301543, arXiv.org.
    12. Zhou, Wei-Xing & Sornette, Didier, 2006. "Fundamental factors versus herding in the 2000–2005 US stock market and prediction," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 360(2), pages 459-482.
    13. Zhou, Wei-Xing & Sornette, Didier, 2003. "2000–2003 real estate bubble in the UK but not in the USA," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 329(1), pages 249-263.
    14. Sornette, Didier & Zhou, Wei-Xing, 2004. "Evidence of fueling of the 2000 new economy bubble by foreign capital inflow: implications for the future of the US economy and its stock market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 332(C), pages 412-440.
    15. Zhou, Wei-Xing & Sornette, Didier, 2005. "Testing the stability of the 2000 US stock market “antibubble”," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 348(C), pages 428-452.
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    Citations

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    Cited by:
    1. Dean Fantazzini, 2011. "Forecasting the Global Financial Crisis in the Years 2009-2010: Ex-post Analysis," Economics Bulletin, AccessEcon, vol. 31(4), pages 3259-3267.
    2. Wanfeng Yan & Ryan Woodard & Didier Sornette, 2010. "Leverage Bubble," Papers 1011.0458, arXiv.org, revised Nov 2010.
    3. Fabian Bocart & Ken Bastiaensen & Peter Cauwels, 2011. "The 1980s Price Bubble on (Post) Impressionism," ACEI Working Paper Series AWP-03-2011, the Association for Cultural Economics International, revised Nov 2011.
    4. Shu-Peng Chen & Ling-Yun He, 2013. "Bubble Formation and Heterogeneity of Traders: A Multi-Agent Perspective," Computational Economics, Society for Computational Economics, vol. 42(3), pages 267-289, October.
    5. Wosnitza, Jan Henrik & Denz, Cornelia, 2013. "Liquidity crisis detection: An application of log-periodic power law structures to default prediction," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 392(17), pages 3666-3681.
    6. Duan, Wen-Qi & Stanley, H. Eugene, 2011. "Cross-correlation and the predictability of financial return series," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 390(2), pages 290-296.
    7. Wanfeng Yan & Ryan Woodard & Didier Sornette, 2010. "Diagnosis and Prediction of Market Rebounds in Financial Markets," Papers 1003.5926, arXiv.org, revised Mar 2011.
    8. Fry, John, 2012. "Exogenous and endogenous crashes as phase transitions in complex financial systems," MPRA Paper 36202, University Library of Munich, Germany.
    9. D. Sornette, 2014. "Physics and Financial Economics (1776-2014): Puzzles, Ising and Agent-Based models," Papers 1404.0243, arXiv.org.
    10. Andreas H\"usler & Didier Sornette & Cars H. Hommes, 2012. "Super-exponential bubbles in lab experiments: evidence for anchoring over-optimistic expectations on price," Papers 1205.0635, arXiv.org.
    11. Yan, Wanfeng & Woodard, Ryan & Sornette, Didier, 2012. "Diagnosis and prediction of rebounds in financial markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 391(4), pages 1361-1380.
    12. Gisler, Monika & Sornette, Didier & Woodard, Ryan, 2011. "Innovation as a social bubble: The example of the Human Genome Project," Research Policy, Elsevier, vol. 40(10), pages 1412-1425.
    13. Didier Sornette & Peter Cauwels, 2014. "A Creepy World," Papers 1401.3281, arXiv.org.
    14. Vladimir Filimonov & Didier Sornette, . "A Stable and Robust Calibration Scheme of the Log-Periodic Power Law Model," Working Papers ETH-RC-11-002, ETH Zurich, Chair of Systems Design.
    15. Filimonov, V. & Sornette, D., 2013. "A stable and robust calibration scheme of the log-periodic power law model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 392(17), pages 3698-3707.
    16. Fry, John, 2013. "Bubbles, shocks and elementary technical trading strategies," MPRA Paper 47052, University Library of Munich, Germany.
    17. Wosnitza, Jan Henrik & Leker, Jens, 2014. "Can log-periodic power law structures arise from random fluctuations?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 401(C), pages 228-250.
    18. Wosnitza, Jan Henrik & Leker, Jens, 2014. "Why credit risk markets are predestined for exhibiting log-periodic power law structures," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 393(C), pages 427-449.
    19. Sornette, Didier & Woodard, Ryan & Yan, Wanfeng & Zhou, Wei-Xing, 2013. "Clarifications to questions and criticisms on the Johansen–Ledoit–Sornette financial bubble model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 392(19), pages 4417-4428.

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