Theorists have been puzzling over why stock markets crash since the 17th century. Market collapse has appalled and fascinated us, and yet the phenomenon is so complex, the antecedents of collapse so uncertain. It seems impossible to understand market failure in hindsight, let alone to predict it.
But the scientific study of complex systems has transformed a wide range of disciplines in recent years, enabling researchers in both the natural and social sciences to model and predict phenomena as diverse as earthquakes, global warming, demographic patterns, financial crises, and the failure of materials. In a ground-breaking analysis published today, Why Stock Markets Fail, Didier Sornette applies his wide experience in these areas to propose a simple, powerful general theory of how, why and, crucially, when stock markets crash.
Most attempts to explain market failures seek to pinpoint triggering mechanisms that occur hours, days, or weeks before the collapse. Sornette proposes a radically different view: the underlying cause can be sought months and even years before the abrupt, catastrophic event in the build-up of cooperative speculation, which often translates into an accelerating rise of the market price, otherwise known as a “bubble.” Anchoring his sophisticated, step-by-step analysis in leading-edge physical and statistical modeling techniques, he unearths remarkable insights and some predictions–among them, that the “end of the growth era” will occur around 2050.
Sornette probes major historical precedents, from the decades-long “tulip mania” in the Netherlands that wilted suddenly in 1637 to the South Sea Bubble that ended with the first huge market crash in England in 1720, to the Great Crash of October 1929 and Black Monday in 1987, to cite just a few. He concludes that most explanations other than cooperative self-organization fail to account for the subtle bubbles by which the markets lay the groundwork for catastrophe.
The end of the growth era will occur around 2050
Any investor or investment professional who seeks a genuine understanding of looming financial disasters should read this book. Physicists, geologists, biologists, economists, and others will welcome Why Stock Markets Crash.
Didier Sornette is professor of entrepreneurial risks at the Swiss Federal Institute of Technology in Zurich, professor of finance at the Swiss Finance Institute in Geneva, and the director of the Financial Crisis Observatory at ETH Zurich.
More from Didier Sornette
- Extreme Financial Risks
- Man-made Catastrophes and Risk Information Concealment
- Theory of Zipf’s Law and Beyond