24 Pages Posted: 6 Feb 2012
Date Written: February 3, 2012
We introduce a new measure of activity of financial markets that provides a direct access to their level of endogeneity. This measure quantifies how much of price changes are due to endogenous feedback processes, as opposed to exogenous news. For this, we calibrate the self-excited conditional Poisson Hawkes model, which combines in a natural and parsimonious way exogenous influences with self-excited dynamics, to the E-mini S&P 500 futures contracts traded in the Chicago Mercantile Exchange from 1998 to 2010. We find that the level of endogeneity has increased significantly from 1998 to 2010, with only 70% in 1998 to less than 30% since 2007 of the price changes resulting from some revealed exogenous information. Analogous to nuclear plant safety concerned with avoiding “criticality”, our measure provides a direct quantification of the distance of the financial market to a critical state defined precisely as the limit of diverging trading activity in absence of any external driving.
Keywords: complex systems, econophysics, exogenous- versus endogenous, high-frequency trading, criticality, trading activity, volume
JEL Classification: C32, C53, G01, G14, G17
Suggested Citation: Suggested Citation
Filimonov, Vladimir and Sornette, Didier, Quantifying Reflexivity in Financial Markets: Towards a Prediction of Flash Crashes (February 3, 2012). Swiss Finance Institute Research Paper No. 12-02. Available at SSRN: https://ssrn.com/abstract=1998832 or http://dx.doi.org/10.2139/ssrn.1998832