Global Stock Market, Knife-Edge Stability and the Crisis

Abstract

This chapter explores whether the global markets are intrinsically unstable following the line of a growing body of the literature and inquires the possible nonlinear, particularly chaotic nature of these markets. The study finds all the markets to be deterministic. While over the first cycle nineteen markets were chaotic, the number increases to twenty four during the second one. Thus stock markets are inherently unstable; or are, at best, stable on knife-edge. Cycles and crashes are manifestations of this inherent instability: norms rather than aberrations. There is no determinate equilibrium and no external shock will be required to gear financial crisis at regular intervals which, in an integrated financial world, will reverberate across the globe in no time. The findings have significant theoretical and policy implications. The relevant equations of motion underlying the nonlinear global stock market return, no doubt can be determined, but it would be nearly impossible to forecast beyond a short time frame. Policy prescriptions, based on the presumption of linearity are likely to be ineffective when applied on a system which is actually nonlinear. At the theoretical level, a chaotic stock market puts efficient market hypothesis on trial and requires reframing of traditional asset pricing models.

You believe in a God who plays dice, and I in complete law and order..,

Albert Einstein

Albert Einstein, Letter to Max Born, September 1944.