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Endogenous versus Exogenous Crashes in Financial Markets

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  • A. Johansen

    (Riso National Lab., Denmark)

  • D. Sornette

    (UCLA and CNRS-Univ. Nice)

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    Abstract

    We perform an extended analysis of the distribution of drawdowns in the two leading exchange markets (US dollar against the Deutsmark and against the Yen), in the major world stock markets, in the U.S. and Japanese bond market and in the gold market, by introducing the concept of ``coarse-grained drawdowns,'' which allows for a certain degree of fuzziness in the definition of cumulative losses and improves on the statistics of our previous results on the existence of ``outliers'' or ``kings.'' Then, for each identified outlier, we check whether log-periodic power law signatures (LPPS) are present and take the existence of LPPS as the qualifying signature for an endogenous crash: this is because a drawdown outlier is seen as the end of a speculative unsustainable accelerating bubble generated endogenously. In the absence of LPPS, we are able to identify what seems to have been the relevant historical event, i.e., a new piece of information of such magnitude and impact that it is seems reasonable to attribute the crash to it, in agreement with the standard view of the efficient market hypothesis. Such drawdown outliers are classified as having an exogenous origin. Globally over all the markets analyzed, we identify 49 outliers, of which 25 are classified as endogenous, 22 as exogeneous and 2 as associated with the Japanese anti-bubble. Restricting to the world market indices, we find 31 outliers, of which 19 are endogenous, 10 are exogenous and 2 are associated with the Japanese anti-bubble. The combination of the two proposed detection techniques, one for drawdown outliers and the second for LPPS, provides a novel and systematic taxonomy of crashes further subtantiating the importance of LPPS.

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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number cond-mat/0210509.

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    Date of creation: Oct 2002
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    Publication status: Published in Shocks, Crashes and Bubbles in Financial Markets, Brussels Economic Review 53 (2), 201-253 (2010)
    Handle: RePEc:arx:papers:cond-mat/0210509

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    References

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    1. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, American Finance Association, vol. 46(5), pages 1575-617, December.
    2. David M. Cutler & James M. Poterba & Lawrence H. Summers, 1988. "What Moves Stock Prices?," NBER Working Papers 2538, National Bureau of Economic Research, Inc.
    3. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262112388, December.
    4. Coe, Patrick J, 2002. "Financial Crisis and the Great Depression: A Regime Switching Approach," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 34(1), pages 76-93, February.
    5. D. Sornette & A. Johansen, 2001. "Significance of log-periodic precursors to financial crashes," Papers cond-mat/0106520, arXiv.org.
    6. Anders Johansen & Didier Sornette, 2000. "The Nasdaq crash of April 2000: Yet another example of log-periodicity in a speculative bubble ending in a crash," Papers cond-mat/0004263, arXiv.org, revised May 2000.
    7. Fabrizio Lillo & Rosario N. Mantegna, 2000. "Symmetry alteration of ensemble return distribution in crash and rally days of financial markets," Papers cond-mat/0002438, arXiv.org.
    8. D. Sornette & Y. Malevergne & J. F. Muzy, 2002. "Volatility fingerprints of large shocks: Endogeneous versus exogeneous," Papers cond-mat/0204626, arXiv.org.
    9. D. Sornette & A. Johansen, 2001. "Significance of log-periodic precursors to financial crashes," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 1(4), pages 452-471.
    10. Sanford J. Grossman & Zhongquan Zhou, 1993. "Optimal Investment Strategies For Controlling Drawdowns," Mathematical Finance, Wiley Blackwell, Wiley Blackwell, vol. 3(3), pages 241-276.
    11. D. Sornette & W. -X. Zhou, 2002. "The US 2000-2002 Market Descent: How Much Longer and Deeper?," Papers cond-mat/0209065, arXiv.org.
    12. A. Johansen & D. Sornette, 1998. "Stock market crashes are outliers," The European Physical Journal B - Condensed Matter and Complex Systems, Springer, Springer, vol. 1(2), pages 141-143, January.
    13. Sornette, Didier & Johansen, Anders, 1998. "A hierarchical model of financial crashes," Physica A: Statistical Mechanics and its Applications, Elsevier, Elsevier, vol. 261(3), pages 581-598.
    14. D. Sornette & A. Helmstetter, 2002. "Endogeneous Versus Exogeneous Shocks in Systems with Memory," Papers cond-mat/0206047, arXiv.org.
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    Cited by:
    1. Tanya Araujo & Francisco Louca, 2007. "The geometry of crashes. A measure of the dynamics of stock market crises," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 7(1), pages 63-74.
    2. D. Sornette & W. -X. Zhou, 2003. "The US 2000-2003 Market Descent: Clarifications," Papers cond-mat/0305004, arXiv.org.

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