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Bubble Diagnosis and Prediction of the 2005-2007 and 2008-2009 Chinese stock market bubbles

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  • Zhi-Qiang Jiang
  • Wei-Xing Zhou
  • Didier Sornette
  • Ryan Woodard
  • Ken Bastiaensen
  • Peter Cauwels
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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 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 and Shenzhen Stock Exchange Component indexes exhibited such behavior in two distinct time periods: 1) from mid-2005, bursting in Oct. 2007 and 2) from Nov. 2008, bursting in the beginning of Aug. 2009. We successfully predicted time windows for both crashes in advance with the same methods used to successfully predict the peak in mid-2006 of the US housing bubble and the peak in July 2008 of the global oil bubble. 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 more detailed analysis of the individual Chinese index predictions and of the methods used to make and test them.

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    File URL: http://arxiv.org/pdf/0909.1007
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 0909.1007.

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    Date of creation: Sep 2009
    Date of revision: Oct 2009
    Publication status: Published in Journal of Economic Behavior & Organization 74 (3), 149-162 (2010)
    Handle: RePEc:arx:papers:0909.1007

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    1. Refet S. G├╝rkaynak, 2005. "Econometric tests of asset price bubbles: taking stock," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2005-04, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:
    1. Didier Sornette & Ryan Woodard & Maxim Fedorovsky & Stefan Reimann & Hilary Woodard & Wei-Xing Zhou, 2009. "The Financial Bubble Experiment: advanced diagnostics and forecasts of bubble terminations," Papers 0911.0454, arXiv.org, revised May 2010.
    2. Vincenzo Liberatore, 2010. "Computational LPPL Fit to Financial Bubbles," Papers 1003.2920, arXiv.org, revised Jan 2011.
    3. Fantazzini, Dean & Geraskin, Petr, 2011. "Everything You Always Wanted to Know about Log Periodic Power Laws for Bubble Modelling but Were Afraid to Ask," MPRA Paper 47869, University Library of Munich, Germany.

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