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An index of market shocks based on multiscale analysis

Bertrand Maillet and Thierry Michel

Quantitative Finance, 2003, vol. 3, issue 2, 88-97

Abstract: Financial markets are places of sudden and violent price movements. Nevertheless, financial crises lack a universally recognized way of assessing their gravity. This has motivated the measure recently proposed and applied to the exchange rates market by Zumbach et al (2000a Int. J. Theor. Appl. Finance 3 347-55). This measure relies on an analogy with geophysics: the scale of market shocks (SMS) is equivalent to the Richter scale used for earthquakes. More precisely, as a market is the place where economic agents—with different investment horizons—interact, the SMS definition is a weighted aggregation of volatility measures corresponding to these different horizons. In this paper, we implement and apply a similar measure to stock markets, and adapt it to take into account some extra features of these markets. The volatilities are first described, and then used to assess the market instability perceived by a market participant. The evolution of our index of market shocks (IMS)—after rescaling for easy interpretation—is presented using different computational methods. The IMS is then compared with another multiscale measure, the multifractal spectrum width, and we also investigate the links between the IMS and the daily close-to-close returns and volatility. Finally, we describe the recent turbulence on the French market using the IMS as an exploratory tool, concluding that the events of September 2001 proved to be a major shock compared to the Russian and Asian crises.

Date: 2003
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Handle: RePEc:taf:quantf:v:3:y:2003:i:2:p:88-97