Examining the dynamical transition in the Dow Jones Industrial Index from Bull to Bear market using Recurrence Quantification Analysis
Date
2012-11-20Author
Moloney, Kitty
Raghavendra, Srinivas
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Abstract
We present evidence of phase transitions (periodic to chaotic and
chaotic to chaotic) in the Dow Jones Industrial Index as it transitions
from Bull to Bear market. There is also evidence of a completely unpredictable
(i.e., nondeterministic) regime just as the market peaks. The
noisy trader theory is suggested as the economic explanation for this unpredictability
i.e. rational but uninformed traders chase noise rather than
the usual macro economic and financial variables. We suggest that the
collapse in determinism allows the dynamics of the market to break from
the past and that the market is in fact piecewise deterministic. A principal
component series is developed and named the random market indicator,
(RMI). This can be used to indicate when the market is transitioning.
The RMI indicator could be used by market participants, financial regulators
and policy makers as an indicator of market crisis. During times of
crises, quantitative risk estimation techniques such as stationary value at
risk models, will give misleading results and should not be used.