Financial Bubbles II

A further look at financial bubbles and the science behind them

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    Stock Market Bubbles -- Jason Zweig Says it's Not Easy to Do

    WSJ Personal Finance columnist Jason Zweig stops by Mean Street to point out that spotting stock market bubbles is harder than it looks.

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    Neuroscience May Help Us Understand Financial Bubbles

    New research published in the journal Neuron suggests that market bubbles are in fact driven by a biological impulse to try to predict how others behave.: "They found two areas of the brain's frontal cortex were particularly active during bubble markets: the area which processes value judgements, and that which looks at social signals and the motives of other people. Increased activity in the former suggests that people are more likely to overvalue assets in a bubble. Activity in the latter area shows participants are highly aware of the behavior of others and are constantly trying to predict their next moves. "In a bubble situation, people start to see the market as a strategic opponent and shift the brain processes they're using to make financial decisions," De Martino said. "They start trying to imagine how the other traders will behave and this leads them to modify their judgement of how valuable the asset is. They become less driven by explicit information, like actual prices, and more focused on how they imagine the market will change.""

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    Mind over money with Paul Zak

    Irrational decision-making is at the heart of our current economic downturn, say psychologists and economists alike. Americans bought homes they couldn't afford, banks handed out overly generous loans, and investors panicked when things looked grim.

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    Is it gullibity?

    Does gullibility increase prior to bubbles?

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    A Literature Review of Social Mood

    (2006). A Literature Review of Social Mood. Journal of Behavioral Finance: Vol. 7, No. 4, pp. 193-203. doi: 10.1207/s15427579jpfm0704_2

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    Not only a good review of bubbles, but a look at risks associated as well

    "Overall, the main problem is not the price correction per se, but the fact that the necessary correction often occurs only very late, at which point risk and large imbalances have built up. The trigger event that catalyzes the crisis does not have to be an event of major economic signi cance when seen by itself. For example, the subprime mortgage market that triggered the recent nancial crisis made up only about 4% of the overall mortgage market. However, because of ampli cation e ects, even small trigger events can lead to major nancial crises and recessions"

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    Is it institutions or not

    An early paper by Lakonishok, Shleifer, and Vishny (1992) concluded institutions were not to blame.

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    Institutional Herding

    Abstract "Institutional investors' demand for a security this quarter is positively correlated with their demand for the security last quarter....Results are most consistent with the hypothesis that institutions herd as a result of inferring information from each other's trades. "

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    Monkeys Follow Social Cues Like People

    New research could give the old saying "monkey see, monkey do" some actual scientific backing.

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    A look at the language of the street

    After examining 18,000 online articles published by the Financial Times, The New York Times, and the BBC, scientists discovered that verbs and nouns used by financial commentators converge in a 'herd-like' fashion in the lead up to a stock market bubble. The findings show that trends in word use financial journalists correlate closely with changes in leading stock indices.

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    Google queries and stock market volumes: Financial markets and Internet's 'swarm intelligence' linked, researchers find

    Financial markets and the 'swarm intelligence' of the internet are linked, according to a new study in which search engine query data were analyzed by Tobias Preis and Daniel Reith (Johannes Gutenberg University Mainz, Germany), together with H. Eugene Stanley (Boston University, USA).

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    Plants and animals under stress may provide the key to better stock market predications

    Stock markets react to crisis in a similar way to plants and the human body, according to a major new study that may help to predict future financial down-turns. An extensive analysis of biological and financial data suggests that systems under stress exhibit similar symptoms, whether they be polluted forests, cancer patients or the FTSE 100. ""By studying the dynamics of correlation and variance in many systems facing external, or environmental, factors, we can typically, even before obvious symptoms of crisis appear, predict when one might occur, as correlation between individuals increases, and, at the same time, variance (and volatility) goes up." This was demonstrated, for example, by an analysis of the impact of emissions from a heat power station on Scots pine. For diagnostic purposes some metabolites in needles are measured. The test group of pines grow in the emission tongue of the power station. The control group was from a stand of the same age and forest type, growing outside the industrial emission area. No reliable difference was found in the test group and control group average compositions. Nevertheless, the sample variance in the test group was 2.56 times higher, and the difference in the correlations was huge: in the test group the correlations were almost five times higher. Many examples from human physiology support this observation: from the adaptation of healthy people to a change in climate conditions to the analysis of fatal outcomes in oncological and cardiological clinics. The same effect is found in the stock market. For example, in the dynamics of the 30 largest companies traded on the London Stock Exchanges, from 14/08/2008 to 14/10/2008 the correlations increased five times and the variance increased seven times."

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    Ordered fear plays a strong role in market chaos

    When the current financial crisis hit, the failure of traditional economic doctrines to provide any sort of early warning shocked not only financial experts worldwide, but also governments and the general public, and we all began to question the effectiveness and validity of those doctrines. "….analyzed the volatility time series of 10 different stock markets from seven countries over a period of about 50 years and, rather than following traditional economic analyses, they analyzed time variations in the volatility -- or the "volatility of volatility," a.k.a. "fear volatility." In all markets studied, analysis revealed the existence of hidden temporal order in the volatility and very high correlations between the volatility and the magnitude of price variations. This marks the first time hidden temporal order has been found in these market "human factors." "To a non-economist, economic theories seem decoupled from human reality. The fundamental assumption is that investments are made rationally. But investors can behave irrationally -- driven largely by greed and fear, and other human factors," explains Ben-Jacob. "It's also odd that many mathematical analyses, such as the design of investment portfolios, assume no memory. It's assumed that stock prices behave with no apparent temporal order. Yet investors, including professional traders, take into account past behavior and are particularly influenced by the variation in prices or the volatility associated with the fear index." The existence of such volatility order, or "ordered fear," implies that proper portfolio design should take into consideration the "volatility of volatility," according to the team. For example, the common approach to reducing risk is to select stocks with negative or low correlations in their sequence of returns. The new findings suggest that selection criteria should incorporate the correlations in the stocks' volatility dynamics. "We're working on incorporating human factors into market analysis," Ben-Jacob says, "by constructing a new parameter to replace the traditional systemic risk parameter." "

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