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

~ (Author) "Stock market crashes are momentous financial events that are fascinating to academics and practitioners alike..." (more)
Key Phrases: ensemble return distribution, power law acceleration, discrete scale invariance, Hong Kong, United States, Dow Jones (more...)

Editorial Reviews

From Publishers Weekly

It’s everybody’s favorite topic of conversation at the moment: why did the Dow and the Nasdaq tank so horrifically, and where did all the money go? UCLA professor Sornette does his best to tackle those questions. While CNBC anchor Ron Insana’s recent Trend Watching took a reader-friendly look at the history of market bubbles, Sornette’s approach is decidedly different. Befitting his status as an expert in geophysics, the author loads the text with enough charts, graphs and advanced economic theory to choke John Kenneth Galbraith (one chapter subheading, for instance, is "The Origin of Log-Periodicity in Hierarchical Systems"). It’s a meaty book, with helpful autopsies of past crashes ranging from tulip mania in the Netherlands to the Nasdaq crash of April 2000, as well as information on how crashes might be predicted in the future. Unfortunately for the average investor who tends to get burned after these bubbles, Sornette’s conclusion is that a mixture of "systemic instability" and plain old human greed means that market bubbles aren’t about to disappear anytime soon. And neither, of course, will the subsequent crashes.
Copyright 2003 Reed Business Information, Inc. --This text refers to the Hardcover edition.

Review

"The author ... has done an admirable job of understanding and appreciating the financial world and its nuances". -- Rick Gorvett, Journal of Risk and Insurance

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Product Details

• Paperback: 448 pages
• Publisher: Princeton University Press (February 23, 2004)
• Language: English
• ISBN-10: 0691118507
• ISBN-13: 978-0691118505
• Product Dimensions: 9.1 x 6.1 x 1.2 inches
• Shipping Weight: 1.3 pounds (View shipping rates and policies)
• Average Customer Review: 4.1 out of 5 stars  See all reviews (31 customer reviews)
• Amazon.com Sales Rank: #178,728 in Books (See Bestsellers in Books)

Customer Reviews

Most Helpful Customer Reviews

21 of 23 people found the following review helpful:

5.0 out of 5 stars Experiment by yourself, February 6, 2003

By A Customer

This review is from: Why Stock Markets Crash: Critical Events in Complex Financial Systems (Hardcover)

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.

17 of 18 people found the following review helpful:

5.0 out of 5 stars An Engaging and Thought-Provoking Work, November 5, 2003

By	Scott Snyder (Northern California) - See all my reviews (REAL NAME)

This review is from: Why Stock Markets Crash: Critical Events in Complex Financial Systems (Hardcover)

If you love to read works on economics, math and physics and love to assemble models of the world, I cannot recommend this book highly enough. Indeed, if economic models were this much fun when I was an undergraduate, I might have become an economist.

Funny thing though, this was not written by an economist, but by a geophysicist.
It seems physicists and psychologists in particular are writing more interesting economics books these days than economists themselves.

The core focus of the book is a derivation of a market model that includes value investors, momentum investors and the herding effect of individual economic agents acting in a world of partial information. The final model is stunning.

Sornette points out the main problem with predicting bubbles: even if all the signs say "yes," there is still a pretty good chance that the bubble will be self-correcting. Turns out chasing market bubbles is a little like chasing soap bubbles - they may simply disappear at any moment. Thus, the book and the model are of limited use in any type of market timing. Indeed, the model suggests that the market should now be in the tank, and yet it continues to hover on the higher side of its expected range.

As much as I loved the book, there was a slight aftertaste that this was all nothing but a very mathematical and high-minded type of technical analysis. That at base, when all was said and done, this was not all that different from the various "tools" in the chartist's handbook, e.g. MACD, RSI and OBV, etc., etc., etc. The difference may be solely that Sornette knows his statistics and would easily and readily dismiss any model which did not perform significantly different from chance.

Finally, this book will have you trotting out your old high school calculus book. It brought back memories of just how much fun mathematics can be.

All in all - I give it 5 stars.

59 of 72 people found the following review helpful:

2.0 out of 5 stars WARNING: Get two Ph.D.'s before opening this book, January 22, 2003

By	Jean-Claude Balland (Beaverton, OR United States) - See all my reviews (REAL NAME)

This review is from: Why Stock Markets Crash: Critical Events in Complex Financial Systems (Hardcover)

Ever since I bought gold at $800 an ounce (the very top) 20 years or so ago, I have been fascinated by financial markets and their tendencies to produce bubbles that fool the majority. I know that complex systems and positive feedback and other phenomenons are at play and I wanted to find a book that covered the topic with enough depth. I thought Sornette's book was the one and some other reviews might make you think it is. Not for me though. Granted, it is extremely well researched with more than 460 references. It covers all the possible theories for stock markets price fluctuations and crashes. But its merit for me stops here.

The author warns the reader at the outset that mathematical explanations in smaller characters could be skipped in a first reading. The problem is that 90% of the book should be in smaller characters. The main text will be as hermetic to most readers than the small characters sections. Unless you have a graduate degree in a mathematics or physics and an extended experience in the disciplines that Sornette covers you'll be lost (BTW I do have one and I was lost). Here is an example of the kind of explanations you will find:

"The novel insight is that the arbitrary bubble component X, of an asset price plays a role analogous to the so-called 'Golstoine mode' in nuclear particle and condensed physics. Goldstone modes are the zero energy infinite-wavelength mode fluctuations that attempt to restore broken symetry."

Did you get it? I didn't.

This book might be of interest to researchers and acdemics in the field but it is way beyond the level of the educated general public. It is regreatble that Mr. Sornette
has chosen such a complex and esoteric way to treat the topic and has not made the slighest attempt to make it understandable to a wider public.

So I will keep looking for the book that will explain the fractal nature of stock markets in a documented but simple and interesting way.