Stock market speculation: Spontaneous symmetry breaking of economic valuation

Didier Sornette

Physica A: Statistical Mechanics and its Applications, 2000, vol. 284, issue 1, 355-375

Abstract: Firm foundation theory estimates a security's firm fundamental value based on four determinants: expected growth rate, expected dividend payout, the market interest rate and the degree of risk. In contrast, other views of decision-making in the stock market, using alternatives such as human psychology and behavior, bounded rationality, agent-based modeling and evolutionary game theory, expound that speculative and crowd behavior of investors may play a major role in shaping market prices. Here, we propose that the two views refer to two classes of companies connected through a “phase transition”. Our theory is based on (1) the identification of the fundamental parity symmetry of prices (p→−p), which results from the relative direction of payment flux compared to commodity flux and (2) the observation that a company's risk-adjusted growth rate discounted by the market interest rate behaves as a control parameter for the observable price. We find a critical value of this control parameter at which a spontaneous symmetry-breaking of prices occurs, leading to a spontaneous valuation in absence of earnings, similarly to the emergence of a spontaneous magnetization in Ising models in absence of a magnetic field. The low growth rate phase is described by the firm foundation theory while the large growth rate phase is the regime of speculation and crowd behavior. In practice, while large “finite-time horizon” effects round off the predicted singularities, our symmetry-breaking speculation theory accounts for the apparent over-pricing and the high volatility of fast growing companies on the stock markets.

Date: 2000
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0378437100002612
Full text for ScienceDirect subscribers only. Journal offers the option of making the article available online on Science direct for a fee of $3,000

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:284:y:2000:i:1:p:355-375

DOI: 10.1016/S0378-4371(00)00261-2

Access Statistics for this article

Physica A: Statistical Mechanics and its Applications is currently edited by K. A. Dawson, J. O. Indekeu, H.E. Stanley and C. Tsallis

More articles in Physica A: Statistical Mechanics and its Applications from Elsevier
Bibliographic data for series maintained by Catherine Liu ().