Thursday, May 19, 2011

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.

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

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