Econophysicists Develop and Test "Bubble Index"

eldavojohn writes "Oh if only we could identify the bubble markets as they appear, but with all the random variables, it would take some sort of econophysicist to build predictions for that! Well, a team has released a definition of a 'bubble index' that led them to make predictions of bubbles six months ago that would pop between then and now. The four bubbles they selected were the IBOVESPA Index of 50 Brazilian stocks, a Merrill Lynch Corporate Bond Index, the spot price of gold, and cotton futures. Two out of the four were bubbles, with Merrill Lynch being a bubble already popping and cotton continuing to soar into even bubblier status. Still, for your first try, 50% isn't bad. The team learned a lot of new things from the first run, revised their method, selected their predictions for the next six months, and sealed them. Only time will tell if they are truly onto predicting crashes."

Comments

Self-fulfilling prophecies

[DavidR1991]

Does no-one see the problem here? If this becomes accurate to predict anything of actual use, the markets themselves will start using it... which renders the predictions themselves useless.

It's like seeing into the future and acting upon what you see - by doing that you alter the future itself, making the initial prediction invalid.

Re:Self-fulfilling prophecies

[snowboardin159]

Maybe they have figured a way to incorporate the fact that acting on future events changes those events, so that even then we can still accurately predict whats really going to happen, not what we are making happen.

Re:Self-fulfilling prophecies

[chrono13]

Psychohistory (Asimov's Foundation series) suffers the same flaw. The key was to have a small group hold the answers, and guide/warn when appropriate. The trouble then becomes selecting a group that we can trust with the wealth of nations, and the power to destroy by proclamation. I don't trust any group with that much power not to grow corrupt. Best that this secret be out and become useless.

Re:Self-fulfilling prophecies

[blair1q]

And then someone comes along saying they have a similar system and front-runs the panics they cause by claiming they foresee a bubble crashing tomorrow.

Re:Self-fulfilling prophecies

[phantomfive]

And so eventually, everyone will feel safe if this predicts it's not a bubble. And they will keep buying, because the algorithm says it's not a bubble. Then finally someone will realize the underlying asset isn't really worth that much and the bubble will pop. Which is kind of what happened in the real estate bubble.....everyone thought real estate wouldn't have a bubble, and then finally it popped (actually that's not entirely true, a lot of people thought it was having a bubble many years before it popped).

Incidentally it can be really hard to distinguish a bubble, because the value of an object is entirely an objective thing. To you, gold may be worth something, to others it is not. To some a boat is worth a lot because you can go fishing and enjoy yourself, to others it is not. To some a tulip bulb may really be worth their entire estate. I find that crazy, but who am I to judge other people's tastes?

Re:Self-fulfilling prophecies

[fractoid]

Right, it's like traffic: if you alert everyone to a blockage somewhere, and everyone reroutes to avoid it, then the alternative routes will get clogged and the original slowed route will now be empty.

That's exactly what you observe on a freeway. There's a merge coming up in the left lane (Australian here, all you backwards U.S. citizens just pretend I'm ambi-dyslexic :P ) so everyone dives into the rightmost lane, which comes to a stop. The fastest way to get through that section of road is to stay in the leftmost lane until the left and middle lanes merge, then try and find a gap in the right lane where some dozy bastard doesn't keep up with traffic. That way you skip the congestion and get into the right lane just as it frees up.

We don't need to predict them...

[davecb]

... in the years after the 2nd world war we used to treat every wild upswing as a bubble and increase the interest rates. Every downturn got a reduction in rates.

It was the same kind of negative feedback that engineers use to prevent oscillation (feedback squeals, for example).

You'll notice it worked. The converse worked much less well.

--dave

Is it really 50%?

[Dice]

How many bubbles did they miss?

Another Tool To Ignore

[cmholm]

Having a new model/metric to play with is nice. But, it wouldn't have made a damn bit of difference with the most recently departed "phantom value". The core issue is that when people are making a lot of money off a hot economic streak, rich people in particular, there's a strong incentive to not screw with the gravy train. Hell, The Economist, for one, had spent three or four years publishing charts and stories suggesting that the western European/North American real estate bubble was unsustainable, and due for correction.

The missing bit of information was exactly what the corrective signal was going to be. The US Federal Reserve - in the person of Mr. Greenspan - could have provided it, but the Fed board is full of conservative bankers that didn't want to rock the GOP's boat. The various Wall Street bankers could have provided it, but instead they were busy putting out increasingly meta-physical financial products to squeeze another round of bonuses out of the market. So instead, they were all Cosmo Kramer, joy-riding the Saab down the expressway for as long as the fumes kept it going.

It doesn't matter what predictive tool you've got, even the Word of the Lord wasn't and isn't going to stop people from trying to grab that extra [your monetary goal here], if there's any money left on the table.

Predicting bubbles is easy. Timing them is hard.

[Animats]

I'm on record as having called the dot-com bubble, the oil spike, and the mortgage crisis. It's not hard to predict bubbles. If you look at historical ratios, it's usually clear when assets are overpriced. Historically, the median house in the US sells for 2x to 2.5x the median income. That's about what people can pay for. That ratio hit 4 nationally, and 10 in some states. It was blindingly obvious that there was a housing bubble.

Dot-com predictions were easy. I had a program which read SEC filings for cash and burn rate, and simply projected when the money would run out. This was far more successful than one would expect. I used to get hate mail from CFOs for that.

The problem is figuring out when a bubble will pop. I expected the mortgage bubble to pop about two years earlier than it did. (Arguably, the Fed's cheap-money policy under Greenspan postponed the inevitable.)

Predictions on the debt side are harder than on the equity side. Public policy dominates the debt world. I don't make political predictions, so I can't say much about the current situation. I've been expecting an interest rate spike for years, but instead we've had a Federal deficit spike as money is pumped into the system. Eventually something will give there, as with Iceland, Greece, and other debtor countries. I'm not sure how that will unwind. We may get an interest rate spike and hyperinflation, which is what usually happens when a currency gets into trouble.