Bubble Diagnosis and Prediction of the 2005-2007 and 2008-2009 Chinese stock market bubbles

Zhi-Qiang Jiang, Wei-Xing Zhou, Didier Sornette, Ryan Woodard, Ken Bastiaensen and Peter Cauwels
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Zhi-Qiang Jiang: East China University of Science and Technology (School of Business, School of Science Research Center for Econophysics)
Didier Sornette: ETH Zurich and Swiss Finance Institute
Ryan Woodard: ETH Zurich
Ken Bastiaensen: BNP Paribas Fortis
Peter Cauwels: BNP Paribas Fortis

No 09-39, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: By combining (i) the economic theory of rational expectation bubbles, (ii) behavioral finance on imitation and herding of investors and traders and (iii) the mathematical and statistical physics of bifurcations and phase transitions, the logperiodic power law (LPPL) model has been developed as a flexible tool to detect bubbles. The LPPL model considers the faster-than-exponential (power law with finite-time singularity) increase in asset prices decorated by accelerating oscillations as the main diagnostic of bubbles. It embodies a positive feedback loop of higher return anticipations competing with negative feedback spirals of crash expectations. We use the LPPL model in one of its incarnations to analyze two bubbles and subsequent market crashes in two important indexes in the Chinese stock markets between May 2005 and July 2009. Both the Shanghai Stock Exchange Composite index (US ticker symbol SSEC) and Shenzhen Stock Exchange Component index (SZSC) exhibited such behavior in two distinct time periods: 1) from mid-2005, bursting in October 2007 and 2) from November 2008, bursting in the beginning of August 2009. We successfully predicted time windows for both crashes in advance [24, 1] with the same methods used to successfully predict the peak in mid-2006 of the US housing bubble [37] and the peak in July 2008 of the global oil bubble [26]. The more recent bubble in the Chinese indexes was detected and its end or change of regime was predicted independently by two groups with similar results, showing that the model has been well-documented and can be replicated by industrial practitioners. Here we present more detailed analysis of the individual Chinese index predictions and of the methods used to make and test them. We complement the detection of log-periodic behavior with Lomb spectral analysis of detrended residuals and (H, q)-derivative of logarithmic indexes for both bubbles. We perform unit-root tests on the residuals from the log-periodic power law model to confirm the Ornstein-Uhlenbeck property of bounded residuals, in agreement with the consistent model of ‘explosive’ financial bubbles [16].

Keywords: stock market crash; financial bubble; Chinese markets; rational expectation bubble; herding; log-periodic power law; Lomb spectral analysis; unit-root test (search for similar items in EconPapers)
JEL-codes: G01 G17 O16 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2009-09
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Citations: View citations in EconPapers (35)

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Related works:
Journal Article: Bubble diagnosis and prediction of the 2005-2007 and 2008-2009 Chinese stock market bubbles (2010)
Working Paper: Bubble Diagnosis and Prediction of the 2005-2007 and 2008-2009 Chinese stock market bubbles (2009)
Working Paper: Bubble Diagnosis and Prediction of the 2005-2007 and 2008-2009 Chinese stock market bubbles
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp0939

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