Dynamics of financial markets

At the outset, ecology and finance may seem to have nothing in common. However, complex ecological dynamics may indeed have many parallels in financial systems. Whereas ecosystems are interconnected network of various individuals and speices who are acting on their own self-interest, financial systems too comprise of individual investors and firms that compete and interact among themselves. The resultant, is that we see the ecosystem or a financial system a collective of interacting units.

We are building a collaborative network to develop interdisciplinary approaches to investigate financial markets deriving ideas from ecological dynamics, micro- and macro-economic theory,  tools of applied mathematics and non-equilibrium statistical physics. Researchers involved in this project are:

Dr. Vishwesha Guttal, Centre for Ecological Sciences, Indian Institute of Science.

Dr. Srinivas Raghavendra, J. E. Cairnes School of Business and Economics, National University of Ireland, Galway

Prof. Srikanth Iyer, Department of Mathematics, Indian Institute of Scienc

Prof. Amit Badhuri, Emeritus Professor, Jawaharlal Nehru University, New Delhi.

In one of the project, we are exploring the idea of tipping points in the context of financial markets. The inspiration comes the analogy between dynamics of financial and ecological systems. Both may show an abrupt change in the state of a system with no apparent changes in the external stimuli (catastrophic transition in ecosystems such as desertification & financial crashes of markets). In addition, these systems may show a delayed recovery to the original state (also called hysteresis).

We are employing the framework of critical transitions that originated in the physics literature in the 1970’s and has recently undergone extensive developments in the context of wider nonequilibrium systems such as ecological, climatic and other complex systems. The theory of critical transitions and nonlinear models have not only offered a phenomenological explanation for abrupt crashes and delayed recovery, they have also proposed early warning signals of impending critical transitions.

We are asking a number of questions such as

(1) Are financial market crashes (such as those of 1929 Great Depression, 1987 Crash, 2000 Dot com bubble or the 2008 Great Recession) tipping points or critical transitions or stochastically driven transitions?

(2) How can we anticipate imminent financial market crashes?

(3) How do individual constituents (e.g. firms) influence, and are influenced by, the financial market that they make (such as Dow Jones Index)?

(4) Can we build a micro- and macro-economic theory of interactions among investors and the market that can explain dynamics of financial crashes?

Relevant Publications from our group:

Vishwesha Guttal, Srinivas Raghavendran, Nikunj Goel, and Quentin HoarauLack of Critical Slowing Down Suggests that Financial Meltdowns Are Not Critical Transitions, yet Rising Variability Could Signal Systemic Risk,  PLoS ONE, 11(1): e0144198. PDF

Amit Badhuri, Srinivas Raghavendra, Vishwesha Guttal, On the Systemic Fragility of Finance Led Growth, Metroeconomica, 66: 158-186.

Vasilis Dakos, Stephen R. Carpenter, William A. Brock, Aaron M. Ellison, Vishwesha Guttal, Anthony R. Ives, Sonia Kefi, Valerie Livina, David A. Seekell, Egbert H. van Nes, Marten Scheffer, 2012, Methods for detecting early warnings of critical transitions in time series: Illustrated using simulated ecological data, PLoS ONE. 7(7): e41010.

Banerjee, T, Ghosh, M. K. and Iyer, S. K.; Pricing Credit Derivatives, Current Science, 103(6), 657-665, 2012

Other relevant publications:

Lux, Thomas. Herd behaviour, bubbles and crashes. The economic journal (1995): 881-896.

Scheffer et al, Catastrophic Shifts in Ecosystems, Nature, 413:591-596 (2001)

May, Levin, Sugihara, Complex systems: Ecology for bankers, Nature, 451:893-895 (2008)

Farmer, J. D. Market force, ecology and evolution. Industrial & Corporate Change, 11:895–953 (2002)

Haldane and May, Systemic risk in banking ecosystems, Nature, 469:351-355 (2011)

Scheffer et al, Early warning signals of critical transitions, Nature, 461: 53-59 (2009)

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