ESHEL BEN-JACOB School of Physics and Astronomy, Tel Aviv University


Econophysics


    Youtube The Epileptic US market

    The Epileptic US Market Requires Surgery

    The US market has been behaving like an epileptic brain since 2002. Remedies, while alleviating some symptoms, might aggravate the underlying malady, rendering the market more prone to systemic collapse. Major surgery is required to restore the market to health.

    In epilepsy, an epilepticfocus in the brain takes over and tampers with the normal activity of other parts (sectors) of the brain. Epilepsy can be controlled but not cured by medications. Recent findings by a team from Tel Aviv University suggest that the current US market financial crisis began already at the end of 2001. Novel market analysis reveals epileptic-seizure-like behavior, which might result from the excessive dominance of the financial sector, affecting the market much like an epileptic focus by tampering with the healthy activity of the other sectors.

    The US financial crisis of 2008 that started with the spotlight on mortgage-backed securities has been cascading into a global economic recession. Consequently, the "market wellbeing" and prognosis of its "illness" became a cardinal concern. Governments, financial experts and laymen alike are troubled by the fact that the traditional economic doctrine failed to give early warnings of the 2008-2009 financial crisis. There seem to be some indications that the financial crisis is under control and recovery is on its way, but many still worry that, while the remedies alleviate the symptoms, they do not cure the problem and can even render the market more prone to systemic collapse.

    In a recent article published in PLoS ONE, the team, led the Physicist Prof. Eshel Ben-Jacob of Tel Aviv University School of Physics and Astronomy, his doctoral student Dror Y. Kenett and the Economist Dr. Gitit Gur-Gershgorn, investigated the time dynamics of the S&P500 during the last decade employing methods originally developed by Prof. Ben-Jacob to analyze brain recording of epilepsy patients. The team studied the correlations between the different stocks, the correlations between the stocks and the index and the residual stock correlations (or partial correlations) after subtraction of the Index effect on the correlations between the stocks as well as the market Entropy (a measure of the variations between the behavior of the different stocks.

    The analysis revealed a fast dramatic transition at the end of 2001, from a healthy market characterized by relatively strong residual correlations into an abnormal market behavior signified by very strong correlations together with vanishing residual correlations. This situation, of strong Index cohesive force (high ratio between the correlations and residual correlations), is a signature of a over dominance of the Index. Such dominance renders the market stiff and prone to systemic collapses. Closer inspection revealed that the anomalously strong Index effect is due to the excessive dominance of the financial sector. This dominance and the consequent market stiffness during this period are manifested in the emergence of market "seizure" behavior - bursts of very high stock correlations that usually coincide with local minima in the Index and high volatility.

     

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    The transition from normal (healthy) market behavior into abnormal seizure-like behavior at the end of 2001 (the vertical dashed line). Top is the S&P Index from March 7 2000 until March 22 2011. The middle panel shows the average stock correlations and the bottom panel shows the average partial correlations (the correlations after subtraction of the Index effect). The decrease in the partial correlations (residual correlations) manifests the abnormal dominance of the Index.

    The team also inspected the network topology of the stock correlations and found a transition from healthy topology of connected yet autonomously behaving sectors into abnormal collapsed topology as seen in the figure.

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    The network topology before the transition (left) and after the transition (right)

    It is proposed that the dangerous excessive dominance of the financial sector might have been a direct consequence of the US hasty and drastic interest cuts and other remedies used in 2001 to overcome the fallout effect of the "dot com" bubble collapse. The abnormal dominance of the financial sector rendered the market prone to a systemic collapse. Hence, eventually, those remedies led to the recent market collapse upon the burst of the subprime bubble and the fall of the Lehman Brothers Bank.

    “Accepting this picture”, says Prof. Ben-Jacob, who also conducts research in human epilepsy, “we realize that while the current US policy makers talk about change, in practice they rely on cosmetic changes and avoid the major and painful surgery needed to cure the market.”
      

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    The S&P500 stock correlation during last decade. Each line corresponds to the correlation of a given stock with all other stocks. The black curve shows the average value of all the stock correlations. The purple vertical line marks the transition from the normal market behavior into the epileptic-like market behavior at the end of 2001.

          008                               010
                    Normal Brain Activity                                                  Epileptic Brain Activity
       Subdural EEG recordings of brain activity from epilepsy patients (voltage as function of time)

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    The transition from normal (healthy) market behavior into abnormal seizure-like behavior at the end of 2001 (the vertical dashed line). Top is the S&P Index from March 7 2000 until March 22 2011. The third panel shows the stock correlations and the second panel shows the partial correlations (the correlations after subtraction of the Index effect. The decrease in the partial correlations manifests the abnormal dominance of the Index. This effect is further pronounced when looking at the Index Cohesive Force – the ratio between the stock correlations and the partial correlations, shown at the bottom panel.

     

     

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    Artist concept illustration of stock correlation network
    superimposed on activity correlation network of epileptic brain
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