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Detecting log-periodicity in a regime-switching model of stock returns

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  • George Chang
  • James Feigenbaum

Abstract

Log-periodic precursors have been identified before most and perhaps all financial crashes of the Twentieth Century, but efforts to statistically validate the leading model of log-periodicity, the Johansen-Ledoit-Sornette (JLS) model, have generally failed. The main feature of this model is that log-harmonic fluctuations in financial prices are driven by similar fluctuations in expected daily returns. Here we search more broadly for evidence of any log-periodic variation in expected daily returns by estimating a regime-switching model of stock returns in which the mean return fluctuates between a high and a low value. We find such evidence prior to the two largest drawdowns in the S&P 500 since 1950. However, if we estimate a log-harmonic specification for the stock index for the same time periods, fixing the frequency and critical time according to the results of the regime-switching model, the parameters do not satisfy restrictions imposed by the JLS model.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal Quantitative Finance.

Volume (Year): 8 (2008)
Issue (Month): 7 ()
Pages: 723-738

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Handle: RePEc:taf:quantf:v:8:y:2008:i:7:p:723-738

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Related research

Keywords: Asset pricing; Bayesian analysis; Log-periodicity; Econophysics; Regime-switching;

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Cited by:
  1. Giacomo Bormetti & Maria Elena De Giuli & Danilo Delpini & Claudia Tarantola, 2008. "Bayesian Analysis of Value-at-Risk with Product Partition Models," Papers 0809.0241, arXiv.org, revised May 2009.
  2. Fry, J. M., 2009. "Bubbles and contagion in English house prices," MPRA Paper 17687, University Library of Munich, Germany.
  3. John M. Fry, 2009. "Statistical modelling of financial crashes: Rapid growth, illusion of certainty and contagion," EERI Research Paper Series EERI_RP_2009_10, Economics and Econometrics Research Institute (EERI), Brussels.
  4. 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.
  5. Fry, John, 2012. "Exogenous and endogenous crashes as phase transitions in complex financial systems," MPRA Paper 36202, University Library of Munich, Germany.
  6. Fry, J. M., 2010. "Bubbles and crashes in finance: A phase transition from random to deterministic behaviour in prices," MPRA Paper 24778, University Library of Munich, Germany.
  7. Fry, John, 2013. "Bubbles, shocks and elementary technical trading strategies," MPRA Paper 47052, University Library of Munich, Germany.
  8. 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.
  9. 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.
  10. 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.
  11. Fry, J. M., 2010. "Gaussian and non-Gaussian models for financial bubbles via econophysics," MPRA Paper 27307, University Library of Munich, Germany.

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