Econophysicists Develop and Test "Bubble Index" 221
eldavojohn writes "Oh if only we could identify the bubble markets as they appear, but with all the random variables, it would take some sort of econophysicist to build predictions for that! Well, a team has released a definition of a 'bubble index' that led them to make predictions of bubbles six months ago that would pop between then and now. The four bubbles they selected were the IBOVESPA Index of 50 Brazilian stocks, a Merrill Lynch Corporate Bond Index, the spot price of gold, and cotton futures. Two out of the four were bubbles, with Merrill Lynch being a bubble already popping and cotton continuing to soar into even bubblier status. Still, for your first try, 50% isn't bad. The team learned a lot of new things from the first run, revised their method, selected their predictions for the next six months, and sealed them. Only time will tell if they are truly onto predicting crashes."
Re:Self-fulfilling prophecies (Score:2, Informative)
Right, it's like traffic: if you alert everyone to a blockage somewhere, and everyone reroutes to avoid it, then the alternative routes will get clogged and the original slowed route will now be empty.
Re:Self-fulfilling prophecies (Score:3, Informative)
The key to the efficient market hypothesis is universal knowledge. Everybody must know everything, reality does not conform.
The GP's point was that the bubble index would be "universal knowledge" and thus could not be exploited for advantage, in the spirit of the Efficient Markets Hypothesis. IANAE and I'm not trying to defend the hypothesis. I'm just saying it's not new.
Re:Self-fulfilling prophecies (Score:3, Informative)
A futures market for Shroedinger's cat? (Score:4, Informative)
A futures market for Shroedinger's cat? Sign me up for that.
A few other thoughts along those lines: Warren Buffet said, "In the short run the market is a voting machine, in the long run it's a weighing machine".
What's interesting about that comment is that he never said what it weighs. People usually infer that it's the value of the company, since Buffet is a value investor. OTOH, the market might really be weighing a number of other things. It might be weighing how much money you have in the first place, since the rich can afford better equipment and advice. It might be weighing the ping time from your office to the exchange, as we've seen with high-frequency traders. It might actually be weighing your skills, and that last one leads to something else.
Let's say, for the sake of argument, that skillful players really can beat the market. Furthermore, let's say that the top 1 % win and the bottom 99 slowly lose. We would expect the 99 to drop out of the market if they were rational. Therein is a fundamental flaw with economics. It assumes people are rational. This is Greenspan's self professed mistake, although IMHO he also failed to realize that firms aren't people and that the people who ran firms into the ground were behaving rationally with respect to their own self-interest (greed). The people who "believed", CEOs, contrary to numbers, were less rational.
So the way I see it, bubbles will continue for the same reason Las Vegas exists. People aren't rational, and nobody really knows where the wheel will be until we OBSERVE that it has stopped spinning.
You Know (Score:1, Informative)
Ron Paul, Peter Schiff, and other Austrian Economists predicted these bubbles for some time now
Re:Is it really 50%? (Score:3, Informative)
This guy fails at predicting bubbles.
Re:Is it really 50%? (Score:1, Informative)
RTFA and look at their graph. They predicted a bubble in gold spot prices and that it would burst and it did. Just because gold is in another bubble does not invalidate their first accurate prediction.
Re:50% for a frist try? (Score:3, Informative)
Bubbles are not like coins, there are no fluctuations in the state of "headness" or "tailness".
Re:Self-fulfilling prophecies (Score:5, Informative)
If the low is artificial, does that mean that the high is artificial?
yes it's all artificial based on the market's perceived value.
Quick simplified example.
Company takes in $1M in stock by selling stock and $1 a price. 100,000 people buy 10 shares each.
10 other people look at what the company is doing with that $1M and think it's a good idea and would be worth lots more so they start saying I'll pay $1.01 a share, $1.02 a share, $1.10 a share...etc until people start selling it. 100 more people see it start going up so they think there must be something going on and say I'll pay $1.20 a share, $1.30 a share, $2.03 a share etc... This is the time of the bubble when people that don't really do any investigation into the market but buy simply because it is going up. At some point there will be some more savoy investors come by and see that the stock is far to high and short sell a stock. A way of borrowing stock at a higher price then getting the difference when you return it at a lower price (or paying the diff if it goes up.) Eventually it'll come out that this company has only been able to turn the $1M into a $1.2M company and not the $2M+ that the market cap has it at and people will start to sell off. This is when the bubble pops.
There are other artificial things that can cause bubbles than just perceived value, like the government backed mortgages causing the real estate bubble.
Color me skeptical (Score:2, Informative)
Re:Self-fulfilling prophecies (Score:5, Informative)
In truth, identifying bubbles is actually remarkably easy. Famed investor Jeremy Grantham defines a bubble as a "3-sigma" event - that is, times when some fundamental ratio of value (such as P/E ratios, price-to-income ratios for housing affordability, price-to-rent ratios, etc.) - is more that 3 standard deviations above the mean for that ratio. Importantly, he showed that of 30-some odd historical bubbles, they ALWAYS popped, ALWAYS giving up more than 100% of the gains during the bubble period.
What is difficult, though, is trying to figure out WHEN a bubble will pop. The Nasdaq was far overvalued in mid 99 - that still didn't prevent it from DOUBLING in early 2000 before it burst.
Grantham also makes a good case as to why bubbles form. Tons of people in the financial world saw that risk was being underpriced in 2006/07. However, what would have happened if a CEO of a major bank would have said back in late 2005 / early 2006 "This is crazy, we're not going be backing these loans given to anyone who can fog a mirror"? That bank would have seriously underperformed its peers for the next two years, and that CEO would have been ousted long before his prudence would have been proven correct.
Re:Color me skeptical (Score:4, Informative)