Financial Bubbles: Mechanisms and Diagnostics

Abstract

Financial bubbles are subject to debate and controversy.

Early Warning Signals of Financial Crises with Multi-Scale Quantile Regressions of Log-Periodic Power Law Singularities

“…We refer to these three additional historical bubbles by the names of the involved markets and the years when they burst. The first one is S&P 500 2007, which was studied in [6,8]. The second and third one are SSEC 2007 and SSEC 2009, discussed in details in [35].…”

“…While informative, the effective use of so many fluctuating and often conflicting signals to inform on the danger for a bubble burst and to trigger an actionable decision remains a challenge. To address this, we propose two indicators that aggregate these signals, inspired from previous works on historic bubbles [6,35,38] via the implementation of pattern recognition of LPPLS structures and filtering, as suggested in Fig 5. These two indicators have been briefly discussed to present the ex-ante forecast of the Chinese bubble and its burst that started in June 2015 [39].…”

“…The data was obtained from the Thomson Reuters Datastream. [6,13], whose end corresponds to a "negative crash" (i.e., a rally or rebound). One can observe that the quantile regressions provide two additional important warning (end of bullish regime in 1994 and rebound in 1998) that are missing in the standard OLS method.…”

“…As financial markets provide both a measure of the health of the underlying economy and an engine for funding firms and catalysing growth, it is urgent to develop new approaches to describe the large price fluctuations and to develop testable diagnostics of financial bubbles. The present article aims at extending the approach pioneered in [1][2][3][4][5][6] to develop novel testable diagnostics of financial bubbles. Real time monitoring and timely early warning of finance bubbles are not only an important part of recent academic research to expand on the efficient market hypothesis.…”

“…The resulting super-exponential price trajectories are inherently unsustainable and often burst as crashes or strong corrections. In a nutshell, the existence of a transient faster-than-exponential price growth can be taken as a signature of bubbles [6,11,12]. The advantage of this definition of a bubble is that it does not rely on the estimation of what is a fundamental value (see e.g., [13]), which is poorly known as mentioned above.…”