Mimicry and Collapse

The stock market is often used for some odd purposes.  Because it is such an amalgamation of complex interactions it is often used as a proxy for complex natural phenomena and where good measurements are available complex physical process are used as proxy for financial markets:  thus the discipline of econophysics which uses methods applied first in the field of physics to the social sciences: economics in particular.

Predicting economic market crises using measures of collective panic

Dion Harmon, Marcus A. M. de Aguiar, David D. Chinellato, Dan Braha, Irving R. Epstein, Yaneer Bar-Yam

Abstract:

Predicting panic is of critical importance in many areas of human and animal behavior, notably in the context of economics. The recent financial crisis is a case in point. Panic may be due to a specific external threat, or self-generated nervousness. Here we show that the recent economic crisis and earlier large single-day panics were preceded by extended periods of high levels of market mimicry — direct evidence of uncertainty and nervousness, and of the comparatively weak influence of external news. High levels of mimicry can be a quite general indicator of the potential for self-organized crises. Ht Alea visa vi Naked Capitalism.

More Commentary from Physorg.com

In addition, the researchers found that the Dow Jones’ eight largest drops (percentage-wise) during the past 26 years occurred during periods in which mimicry reached a level that was twice the standard deviation from the previous year. This signature increase in mimicry occurred before the drops by less than a year, indicating that crashes are preceded by nervousness that causes investors to demonstrate increasingly collective behavior. For this reason, the simple signature pattern could provide advance warning of an impending crash.

I am not sure why they use the term nervousness to describe the antecedent emotions to the collective behavior.  People can jump on a bandwagon for a number of reasons.  Being on a band wagon offers safety within the herd, but if the herd as a whole comes to be at risk:  big problems.  Sort of like a herd of cattle driving itself over a cliff in a lightning storm.  Somewhere in the math and charts of this research, there is probably a reasonable corollary to behavior within our larger society.  But digging out the data would be a bear.