IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this article or follow this journal

Significance of log-periodic precursors to financial crashes

  • D. Sornette
  • A. Johansen
Registered author(s):

    We clarify the status of log-periodicity associated with speculative bubbles preceding financial crashes. In particular, we address Feigenbaum's criticism ([A article="1469-7688/1/3/306"] Feigenbaum J A 2001 Quantitative Finance1 346-60 [/A]) and show how it can be refuted. Feigenbaum's main result is as follows: 'the hypothesis that the log-periodic component is present in the data cannot be rejected at the 95% confidence level when using all the data prior to the 1987 crash; however, it can be rejected by removing the last year of data' (e.g.�by removing 15% of the data closest to the critical point). We stress that it is naive to analyse a critical point phenomenon, i.e., a power-law divergence, reliably by removing the most important part of the data closest to the critical point. We also present the history of log-periodicity in the present context explaining its essential features and why it may be important. We offer an extension of the rational expectation bubble model for general and arbitrary risk-aversion within the general stochastic discount factor theory. We suggest guidelines for the use of log-periodicity and explain how to develop and interpret statistical tests of log-periodicity. We discuss the issue of prediction based on our results and the evidence of outliers in the distribution of drawdowns. New statistical tests demonstrate that the 1% to 10% quantile of the largest events of the population of drawdowns of the NASDAQ composite index and of the Dow Jones Industrial Average index belong to a distribution significantly different from the rest of the population. This suggests that very large drawdowns may result from an amplification mechanism that may make them more predictable.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://www.tandfonline.com/doi/abs/10.1088/1469-7688/1/4/305
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

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

    Volume (Year): 1 (2001)
    Issue (Month): 4 ()
    Pages: 452-471

    as
    in new window

    Handle: RePEc:taf:quantf:v:1:y:2001:i:4:p:452-471
    Contact details of provider: Web page: http://www.tandfonline.com/RQUF20

    Order Information: Web: http://www.tandfonline.com/pricing/journal/RQUF20

    No references listed on IDEAS
    You can help add them by filling out this form.

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:taf:quantf:v:1:y:2001:i:4:p:452-471. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Michael McNulty)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.