Pattern: Stock Crashes & Earthquakes

InferiorWang · May 17, 2003

I got this fro the "What's New" part of AIM. I guess the machines need to write a better program (hehe Matirx). One thing that has always pointed towards the existence of God for me is the fact that everything in this world is beautifully balanced with mathematics in ways you wouldn't expect. This is no exception.

Stock market crashes and earthquakes have one thing in common: Their frequency follows similar mathematical patterns, according to a new study from the Massachusetts Institute of Technology that was published in the journal Nature.

When it comes to forecasting earthquakes, something that may be more of an art than a science, mathematicians have relied on something they call "power laws," which are the mathematical relationships between the frequency of large and small events. "We have found that the artificial world of the financial markets follows a pattern similar to one found in the natural world," MIT professor Xavier Gabaix told Reuters. Both earthquakes and stock market trading are random and can't be predicted, but mathematicians have noticed that patterns emerge. The odds of a market crash can be determined by looking at past returns and trading activity of powerful market players, reports Reuters.

The experiment: The MIT team studied 100 million financial transactions made in several markets around the world from 1994 to 1996. They specifically concentrated on large traders with assets of more than $100 million. They noted the daily volume of stocks traded, the number of trades made, and the fluctuations in price.
The results: The volume, trades, and price changes all followed power laws. The number of funds that manage $1 billion is twice the number of funds with $2 billion, which is twice the number of funds with $4 billion and so on. Reuters explains: "The actions of big players produce power-law behavior, when they trade stock under time pressure. So many of the large movements of the market can be traced back to the behavior of the big players."
Here's the bad news: The elements that make the stock market go up and down and follow the power laws are so strong that crashes would be difficult to prevent. Just like earthquakes. And both can be just as devastating.
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Pattern: Stock Crashes & Earthquakes

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