Friday, February 16, 2007

Interesting Paper

I was reading some papers the other day and came across a very interesting paper regarding the 1987 stock market crash. What was particularly interesting was that this paper appeared in Physical Review Letters, which is probably the top physics journal in the world. (I have one paper published in it and have another being reviewed.)

I'll try to summarize the basic points of the paper. Usually stock prices move in small increments that can be modelled by a Gaussian distribution (bell-curve), with large price moves being less probable than small ones (The Black-Scholes model). The authors analyzed a 2-month period surrounding the market crash of 87 and found that there were large fluctuations that were equally probable on many different time-scales in the weeks preceding the crash. Basically it was a breakdown of the Black-Scholes model and made a crash much more probable.
Interestingly, this behavior is quite similar to the behavior of electron spin in a phase transition of a ferromagnetic metal, or in the behavior of heart muscles between heartbeats.

The authors think that their method could help analysts asses risk.
A very interesting paper, indeed. The link is here, but you need to access it through a local library or university.


Anonymous said...

Hi Paul,
Greetings from Spain! I came to your blog several weeks ago searching for blogs that mentioned FTK and I have become a loyal reader since then. Congratulations on a great blog! I also used to be somewhat bearish, but I have been turning more and more bullish in the last few weeks.
Reading about your background, I was curious to know your view on LMRA. I find their product quite revolutionary, and the company is valued at less than $100M.

Paul Stiles said...

Hello Ariel,

I've noticed that I have been recieving regular hits from a location in Spain. It is nice to know that it was coming from a real person. Thanks for the kind words about the blog.

The chart of LMRA looks very interesting. I'll do some reading on the fundamentals and post an opinion in the near future.

I hope you continue to read, Ariel. Good luck.