SSE Composite Index Bubble II
Posted by John Baez
You’ll recall from my earlier blog entry that on July 10th, a team led by the geophysicist Didier Sornette predicted a crash in the Shanghai Stock Exchange Composite Index. They said it would happen between July 17th and 27th, with 60% probability.
Now some say they were right.
According to the New Scientist:
Physicists successfully predict stock exchange plunge
28 August 2009
With 20/20 hindsight, financial crashes seem inevitable, yet we never see them coming. Now a team of physicists and financiers have bucked the trend by successfully predicting a steep fall in the Shanghai Stock Exchange.
Their model, which employs concepts from the physics of complex atomic systems, was developed by Didier Sornette of the Financial Crisis Observatory in Zurich, Switzerland, and Wei-Xing Zhou of the East China University of Science and Technology in Shanghai. The idea is that if a plot of the logarithm of the market’s value over time deviates upwards from a straight line, it’s a clear warning that people are investing simply because the market is rising rather than paying heed to the intrinsic worth of companies. By projecting the trend, the team can predict when growth will become unsustainable and the market will crash.
Sornette, Zhou and colleagues applied their model to the Shanghai Composite Index, which tracks the combined worth of all companies listed on the Shanghai Stock Exchange, the world’s second largest. Early this year, the index gained 50 per cent in just four months. In July, the team predicted that the index would start to fall sharply by 10 August (arXiv:0907.1827). The index duly began to slide on 4 August, falling almost 20 per cent in the subsequent two weeks.
Anyone hoping to exploit the model for profit should think twice. “If enough investors take action based on our predictions, the evolution of prices will probably be affected,” says Zhou.
I’m not sure how the earlier claim that the plunge would occur “between July 17th and 27th, with 60% probability” squares with the above remark that Sornette’s team predicted it would happen “by 10 August”. But I’m also not sure that matters much.
Presumably there will be better places to find a detailed post-mortem than the frequently inaccurate New Scientist. Does anyone know where?
Thanks go to Robert Schlesinger for pointing out this item.
Re: SSE Composite Index Bubble II
I know this is sounding like a stuck MP3 track…:
Regarding the comment “I’m not sure it matters much.” Here the difference with physics asserts itself: there’s only one (up to isomorphisms and modulo unobservable entities) fundamental physical explanation for a given event. In contrast this kind of model building and analysis is deliberately not trying to build a model of the “fundamental explanation” for the phenomena but trying to select just the tiny subset of the influencing “variables” that happen to be highly predictive. In which case you can’t really choose between models on the basis of which is “most true model”, you can only do it based on some statistical measure. The machine learning community has come up with myriad of ways of computing statitics for selecting models (which models often implicitly include training and evaluation algorithms) given multiple competitors. These measures may even vary depending on your purpose: if you’re the Shanghai government trying to predict the taxes you’ll get from trading over the next year then being off by just over a week isn’t significant; if you’re an individual investor then being off by a week may dramatically reduce your trading account balance.
In case this sounds like I’m down on Sornette’s team, I’m not: it sounds like on an intuitive evaluation they’ve done quite well, this just highlights the difference in viewpoint (particuarly with respect to evaluation) that one needs to make when working in these kind of areas.