Marsili, Matteo, 1966- and Raffaelli, G. (Giacomo) (2006) Risk bubbles and market instability. Working Paper. Warwick Business School, Financial Econometrics Research Centre, Coventry.

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Abstract

We discuss a simple model of correlated assets capturing the feedback effects induced by portfolio investment in the covariance dynamics. This model predicts an instability when the volume of investment exceeds a critical value. Close to the critical point the model exhibits dynamical correlations very similar to those observed in real markets. Maximum likelihood estimates of the model’s parameter for empirical data indeed confirms this conclusion. We show that this picture is confirmed by the empirical analysis for different choices of the time horizon.

Item Type:	Working or Discussion Paper (Working Paper)
Subjects:	H Social Sciences > HG Finance
Divisions:	Faculty of Social Sciences > Warwick Business School > Financial Econometrics Research Centre Faculty of Social Sciences > Warwick Business School
Library of Congress Subject Headings (LCSH):	Portfolio management, Analysis of covariance, Risk assessment, Estimation theory
Series Name:	Working papers (Warwick Business School. Financial Econometrics Research Centre)
Publisher:	Warwick Business School, Financial Econometrics Research Centre
Place of Publication:	Coventry
Date:	12 January 2006
Number:	No.06-
Number of Pages:	14
Status:	Not Peer Reviewed
Access rights to Published version:	Open Access
References:	[1] Challet D., Marsili M. and Zhang Y-C. Minority Games. Interacting agents in financial markets Oxford University Press (Oxford, 2004) [2] Challet D. and Marsili M. Phys. Rev. E 68 (3) 036132 (2003) [3] J.-P. Bouchaud and M. Potters Theory of financial risk and derivative pricing: from statistical physics to risk management (Cambridge University Press, Cambridge, 2003); R. Mantegna and E. Stanley, Introduction to Econophysics (Cambridge University Press, 1999). [4] G. Raffaelli and M. Marsili, eprint physics/0508159. [5] Elton E.J. and Gruber M.J., Modern Portfolio theory and investment analysis (J. Wiley & sons, New York, 1995). [6] Laloux L, Cizeau P, Bouchaud JP, Potters M Phys. Rev. Lett. 83 (7) 1467-1470 (1999) and Plerou V, Gopikrishnan P, Rosenow B, Amaral LAN, Stanley HE Phys. Rev. Lett. 83 (7) 1471-1474 (1999) [7] Bonanno G, Caldarelli G, Lillo F, Mantegna RN, Phys. Rev. E 68 4, 046130 (2003) [8] Plerou V, Gopikrishnan P, Rosenow B, Amaral N.A.N. and Stanley H.E., Phys. Rev. Lett. 83 (7) 1471-1474 (1999). [9] Giada L. and Marsili M. Phys. Rev. E 63 (6) 061101 (2001) [10] Marsili M. Quant. Fin. 2 297-302 (2002) [11] Kwapien J, Drodz S. and Speth J, Phys. A 330 (3-4) 605-621 (2003) [12] Potters M. , Bouchaud J.P. and Laloux L., cond-mat/0507111 [13] Onnela JP, Chakraborti A, Kaski K, Kertesz J, Kanto A, Phys. Rev. E 68 (5) 056110 (2003) [14] Data was taken form finance.yahoo.com in the time period June 16th 1997 to May 25th 2005 for all assets except for the Dow Jones, for which we used May 2nd 1995 to May 23rd 2005. Correlations were measured on the set of assets composing the index at the final date. [15] Drodz S, Kwapien J, Grummer F, Ruf F and Speth J, Phys. A 299 (1-2), 144-153 (2001) and Drodz S, Grummer F, Ruf F and Speth J, Phys. A 294 (1-2), 226-234 (2001). [16] We use Bra-ket notation: |x! should be considered as a column vector, whereas #x| is a row vector. Hence #x|y! is the scalar product and |x!#y| is the direct product, i.e. the matrix with entries ai,j = xiyj . [17] G. Bianconi and M. Marsili, Phys. Rev. E 70, 035105 (2004).
URI:	http://wrap.warwick.ac.uk/id/eprint/1746

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