Detecting Bubbles by Didier Sornette

November 7, 2011

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The most effective diagnosis comes from combining the anecdotal (maids quitting to flip property), the mathematical (exponential growth in credit) and the technical (parabolic up move, increased volatility).

Some have had success with power laws, although they still tend to underestimate the probability of tail events, said Nasim Taleb. Another model has been developed by Didier Sornette, author of “Why Stock Markets Crash.”

  • cited the work by John Kenneth Galbraith
  • studied 50 different bubbles
  • Use a log linear chart
  • Look for “super exponential price acceleration”
  • example : the population explosion is a bubble

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  • Bubbles are susceptible to crashes, defined as a 15% loss in less than 2 weeks.
  • Attributes bubbles to positive feedback loops and herding. This stems from man’s nature to imitate
  • The effects are amplified by credit (HS- induced by artificially cheap interest rates or money printing).

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  • Net Foreign Capital inflow is a sign of bubble, preceded 1997 crash, 2008 housing crash, 1929 crash

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  • News sentiment tends to be confirming.

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  • The stock market is a predictor of the 3 month Fed Funds Rate

How to Detect an Asset Bubble

Log-Periodic Oscillation Analysis Forecasts the Burst of the “Gold Bubble” in April – June 2011

Aleph Blog , About the Market

 

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