Spurious switching points in traded stock dynamics

May 15, 2012

Physicists have rebuffed the existence of power laws governing the dynamics of traded stock volatility, volume and intertrade times at times of stock price extrema. They did this by demonstrating that what appeared as "switching points" in financial markets trends was due to a bias in the interpretation of market data statistics. This study by Vladimir Filimonov and Didier Sornette from the Department of Management, Technology and Economics at ETH Zurich in Switzerland is about to be published in the European Physical Journal B.

The authors noticed that increasing misinterpretations of market dynamic stemmed from statistical analysis of conditional probability: the probability that an event will occur, subject to a prior event occuring. A previous study based on such statistics suggested that the local maxima of volatility and volume, and local minima of intertrade times are akin to switching points in financial returns, reminiscent of critical transition points in physics between two phases, e.g. liquid and gas. These local extrema were thought to follow approximate power laws in time scales ranging from milliseconds to years.

To disentangle the effect of the conditional statistics on the market data trends, the authors compared traded on the financial market with a known of price featuring simple random behaviour, called Geometrical (GBM). They demonstrated that "switching points" occur in the GBM model, too.

The authors found that, in the case of volatility data, the misguided interpretation of switching points stems from a bias in the selection of price peaks that imposes a condition on the statistics of price change, skewing its distributions. Under this bias, switching points in volume appear naturally due to the volume-volatility correlation. For the intertrade times, they showed that extrema and power laws result from the bias introduced in the format of .

Explore further: Professor takes madness out of the month

More information: Filimonov V., Sornette D. (2012), Spurious trend switching phenomena in financial markets, European Physical Journal B (EPJ B) DOI 10.1140/epjb/e2012-21060-1

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User comments : 3

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1 / 5 (1) May 15, 2012
Ah, still trying to crack the market's code. If they can figure out how to predict the market, once the knowledge becomes known, the market will then take that information into account and become unpredictable again.

The only way to be able to predict the market accurately is to have Maxwell's demon that has a perfect understanding of human psychology. Maybe one day but it won't happen this century.
3 / 5 (2) May 15, 2012
It's sad to see economists misusing statistics... Especially since statistics are pretty much the only thing they're really supposed to be competent at. Oh well, I suppose that's why they didn't become scientists or mathematicians.
not rated yet May 19, 2012
I love when people are so ridiculous that they think that economists should understand mathematics. If you're not a physicist or mathematician, you won't understand mathematics. Sorry, that's just life... axemaster :(

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