How can you predict and possibly even prevent the next big market crash or economic slump? By looking at natural disasters and ecological calamities.
At least this is what scientists at the Indian Institute of Science (IISc), along with those from National University of Ireland, Galway, and ENS Cachan, France, are trying to find out in an interdisciplinary study. Financial markets are suggested to be like ecological systems with complex feedback loops and sudden critical transitions, also known as “tipping points”, said a release from the IISc on the study. A stock market crash can, therefore, be compared to unexpected natural transitions such as the onset of Ice Age or desertification of a fertile area.
Many complex systems in nature exhibit “critical slowing down” behaviour before reaching their tipping point, which means that just before a critical transition, it takes longer for them to recover from small disturbances because their internal stabilising mechanisms become weak. The system stays “disturbed” for a longer time than usual. Mathematically, one measures this as an increase in variability and autocorrelation in system parameters.
Autocorrelation indicates how similar the data is across different time samples. This means that once markets are “disturbed”, recovery happens as usual without a “slowing down.”