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Quantifying reflexivity in financial markets: Toward a prediction of flash crashes

Vladimir Filimonov*

Didier Sornette†

  • Department of Management, Technology and Economics, ETH, Zürich, Switzerland

  • Department of Management, Technology and Economics, ETH, Zürich, Switzerland and Swiss Finance Institute, c/o University of Geneva, Geneva, Switzerland

  • *vfilimonov@ethz.ch
  • †dsornette@ethz.ch
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Phys. Rev. E 85, 056108 – Published 9 May, 2012

DOI: https://doi.org/10.1103/PhysRevE.85.056108

Abstract

We introduce a measure of activity of financial markets that provides a direct access to their level of endogeneity. This measure quantifies how much of price changes is 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 measures concerned with avoiding “criticality,” our measure provides a direct quantification of the distance of the financial market from a critical state defined precisely as the limit of diverging trading activity in the absence of any external driving.

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Phys. Rev. E 85, 056108– Published 9 May, 2012
  • Received 26 January 2012

©2012 American Physical Society

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