Why Stock Markets Crash: Critical Events in Complex Financial Systems (Paperback)

by Didier Sornette (Author)

By A Customer

I must confess that I read Didier Sornette's book with much pleasure; and I also read the reviews posted on this site in particular those who contend that, unless you are Stephen Hawking, you will be unable to grasp the message the book  conveys. Well, as I'm not Hawking this opens a debate which is worth some moments of reflexion.

Before seventeenth century physicists unraveled the mysteries of vacuum and atmospheric pressure, the accepted explanation, we are told, was that "nature is averse to vacuum". Obviously, such an anthropomorphic explanation is both easy to grasp and
intuitively appealing. Although based on a number of nice experiments, the scientific framework which replaced it did not have the simplicity and intuitive attractiveness of the
former statement.
Why do stock markets crash? Well, the answer is very simple. Because investors are averse to uncertainty, because of an abrupt change in their mood and overall
utility function. OK. But unless, we can assess and measure in some objective and quantitative way either market uncertainty or the investors' global utility function, we will not go very far with such kind of explanations.

Now, let us come back to Didier Sornette's book. The author proposes a new framework which is based both on a set of new ideas and new scientific tools. As to the ideas one can mention the two following.
* Stock market boom-crashes are a recurrent process, which implies that they can be studied from a comparative perspective. Specifically this means that it makes sense to compare the crash of the Paris stock market in 1881 and the crash of the NASDAQ market in March 2000.
* What happens on stock markets is the result of the COLLECTIVE BEHAVIOR of agents which means that the decision which I take today depends upon what my friends or colleagues David, John and Stanley have done (and vice versa).

Simple as they may seem, these two ideas are quite innovative. Even in the circle of behavioral economists few (if any) researchers would probably accept them altogether.

Naturally, in order to translate these ideas into workable models we need some mathematical tools. Is it at that point that I need to be Hawking? I don't think so. Discrete scale invariance or log-periodicity techniques are not more complicated than modern theories of equity arbitrage or Ito's lemma (which is used in continuous time arbitrage theory), but these techniques are less familiar to us and we therefore need some time to get acquainted with them. Through numerous figures and graphs this book provides an introduction to these techniques which is aimed for newcomers and pedestrians.

Of course, you don't need to take my view as gospel truth, just experiment by yourself.