Quantifying Reflexivity in Financial Markets: Towards a Prediction of Flash Crashes

24 Pages Posted: 6 Feb 2012

See all articles by Vladimir Filimonov

Vladimir Filimonov

Swiss Federal Institute of Technology Zurich (ETH Zurich)

Didier Sornette

Risks-X, Southern University of Science and Technology (SUSTech); Swiss Finance Institute; ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Tokyo Institute of Technology

Date Written: February 3, 2012

Abstract

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

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

Vladimir Filimonov

Swiss Federal Institute of Technology Zurich (ETH Zurich) ( email )

Scheuchzerstrasse 7, SEC F3
Zurich, CH-8092
Switzerland

Didier Sornette (Contact Author)

Risks-X, Southern University of Science and Technology (SUSTech) ( email )

1088 Xueyuan Avenue
Shenzhen, Guangdong 518055
China

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

Tokyo Institute of Technology ( email )

2-12-1 O-okayama, Meguro-ku
Tokyo 152-8550, 52-8552
Japan

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
750
Abstract Views
4,151
Rank
62,361
PlumX Metrics