Financial black swans driven by ultrafast machine ecology

"ABSTRACT

Society’s drive toward ever faster socio-technical systems, means that there is an urgent need to understand the threat from ‘black swan’ extreme events that might emerge4-19. On 6 May 2010, it took just five minutes for a spontaneous mix of human and machine interactions in the global trading cyberspace to generate an unprecedented system-wide Flash Crash4. However, little is known about what lies ahead in the crucial sub-second regime where humans become unable to respond or intervene sufficiently quickly20,21. Here we analyze a set of 18,520 ultrafast black swan events that we have uncovered in stock-price movements between 2006 and 2011. We provide empirical evidence for, and an accompanying theory of, an abrupt system-wide transition from a mixed human-machine phase to a new all-machine phase characterized by frequent black swan events with ultrafast durations (<650ms for crashes, <950ms for spikes). Our theory quantifies the systemic fluctuations in these two distinct phases in terms of the diversity of the system’s internal ecology and the amount of global information being processed. Our finding that the ten most susceptible entities are major international banks, hints at a hidden relationship between these ultrafast ‘fractures’ and the slow ‘breaking’ of the global financial system post-2006. More generally, our work provides tools to help predict and mitigate the systemic risk developing in any complex socio-technical system that attempts to operate at, or beyond, the limits of human response times..."

at http://arxiv.org/ftp/arxiv/papers/1202/1202.1448.pdf

HUSSMAN: The Market Looks Exactly Like It Did Before The Last Crash

"In his latest weekly note, fund manager John Hussman is... bearish on the market.
This has been his stance for a couple years now, and this week he looks at a technical indicator showing signs of excessive optimism:

As of Friday, the S&P 500 was within 1% of its upper Bollinger band at virtually every horizon, including daily, weekly and monthly bands. The last time the S&P 500 reached a similar extreme was Friday April 29, 2011, when I titled the following Monday's comment Extreme Conditions and Typical Outcomes . I observed when the market has previously been overbought to this extent, coupled with more general features of an "overvalued, overbought, overbullish, rising yields syndrome", the average outcome has been particularly hostile:

"Examining this set of instances, it's clear that overvalued, overbought, overbullish, rising-yields syndromes as extreme as we observe today are even more important for their extended implications than they are for market prospects over say, 3-6 months. Though there is a tendency toward abrupt market plunges, the initial market losses in 1972 and 2007 were recovered over a period of several months before second signal emerged, followed by a major market decline. Despite the variability in short-term outcomes, and even the tendency for the market to advance by several percent after the syndrome emerges, the overall implications are clearly negative on the basis of average return/risk outcomes."

As it happened, April 29, 2011 turned out to mark the exact high of the S&P 500 for the year, and was followed by a steep intermediate market plunge. My impression is that despite the recent run of speculation the market has enjoyed - largely reflecting a reprieve in European debt concerns and what appears to be a drawing-forward of jobs into the first quarter due to unseasonably favorable weather - the extended implications of present market conditions remain decidedly negative..."

at http://www.businessinsider.com/hussman-the-market-is-now-exactly-like-the-last-time-the-market-crashed-2012-3#ixzz1pZnFVihH

THE ST. LOUIS FED’S FINANCIAL STRESS INDEX ON THE RISE

"The St. Louis Fed’s financial stress index has recently started to rise again. This relatively new index was created recently to gauge the health of the financial markets..."

at http://pragcap.com/the-st-louis-feds-financial-stress-index-on-the-rise