Interpreting Data from an Experiment on Irrational Exuberance: Applying a Cusp Catastrophe Model and Technical Analysis

Abstract

A Catastrophe Theory Model modified for the explanation of the evolution/revolution of behavior in the securities market can be classified in the realm of behavioral finance. (See Thaler, 1993; Statman, 1998 and Pruden, 1989). An early model of the Cusp Catastrophe Model modified to explain speculative crashes appeared in Zeeman (1976, 1977). Later, Pruden (1979) expanded upon Zeeman's use of the Cusp Model version of Catastrophe Theory to allow for "buying stampedes" as well as "selling panics". Pruden (1980) also established connections between the Cusp Catastrophe Model and technical market analysis. Whereas the Catastrophe Theory Model, like other models from the behavioral sciences, provides a positive scientific theory as to the "why" of behavior in the stock market, technical market analysis furnishes a nominal theory of rules and principles about "how" a trader or investor may profit from the behavior observed in the stock market. Hence, the presupposition is that behavioral science models that explain the stock market behavior provide solid scientific foundations upon which to base the principles and practices of technical market analysis.

Keywords: Catastrophe Theory Model, behavioral finance, technical analysis, finance model

JEL Classification: C53, C6, D6, E44, G14