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A Langevin approach to stock market fluctuations and crashes

Author

Listed:
  • Jean-Philippe Bouchaud

    (Science & Finance, Capital Fund Management
    CEA Saclay;)

  • Rama Cont

    (Science & Finance, Capital Fund Management)

Abstract

We propose a non linear Langevin equation as a model for stock market fluctuations and crashes. This equation is based on an identification of the different processes influencing the demand and supply, and their mathematical transcription. We emphasize the importance of feedback effects of price variations onto themselves. Risk aversion, in particular, leads to an up-down symmetry breaking term which is responsible for crashes, where `panic' is self reinforcing. It is also responsible for the sudden collapse of speculative bubbles. Interestingly, these crashes appear as rare, `activated' events, and have an exponentially small probability of occurence. We predict that the shape of the falldown of the price during a crash should be logarithmic. The normal regime, where the stock price exhibits behavior similar to that of a random walk, however reveals non trivial correlations on different time scales, in particular on the time scale over which operators perceive a change of trend.

Suggested Citation

  • Jean-Philippe Bouchaud & Rama Cont, 1998. "A Langevin approach to stock market fluctuations and crashes," Science & Finance (CFM) working paper archive 500027, Science & Finance, Capital Fund Management.
    • Handle: RePEc:sfi:sfiwpa:500027
    as

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    References listed on IDEAS

    as
    1. A. Johansen & D. Sornette, 1998. "Stock market crashes are outliers," The European Physical Journal B: Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 1(2), pages 141-143, January.
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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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