Stock Market endogenous dynamic.

Empirical observations of the U.S. stock market and of agent based models show catostrophic “avalanches” of volatility that could not be explained by existing financial models. - J.P. Bouchaud

1963,97- B. Mandelbrot
“The variation of certain speculative prices”
“Fractals and Scaling in Finance”
Stock price changes have fat tails deviating from the Gaussian distribution.

1989- R. Shiller
“Market Volatility
Fat tails correspond to avalanches of volatility that could not be explained by fundamental economics.

1994 - P. Bak and M. Paczuski
“Complexity, contingency, and criticality”:
Large dynamical systems tend “to organize themselves into a critical state, with avalanches” of all sizes.
“biology, history, and economics can be viewed as dynamical systems”
“In the critical state, events which would otherwise be uncoupled become correlated”.
“General equilibrium theory” has not been explicitly formulated for biology”, and this is why the avalanches of volatility could not be explained.
a non-equilibrium theory of economics can be constructed and it “will not be beautiful; it trivializes all the nuances and details that make complex systems exciting for humans”

1997 - P. Bak, M. Paczuski and M. Shubik
“Price Variations in a Stock Market with Many Agents”:
“rational optimizer” behavior is driven from economic analysis.
“noise traders” behavior is driven by market dynamics.
When the RELATIVE number of rational traders is small, “bubbles” often occur.
When the number of rational traders is larger, the market price is generally locked within the price range they define.

1999 - P. Bak, S. F. Norrelykke, and M. Shubik
“The Dynamics of Money”:
“in reality, agents usually make decisions locally and sequentially”
“money stores value between transactions”
“money is essentially a dynamical phenomenon, since it is intimately related to the temporal sequence of events.”
“Thus, the value of money is a “strategic variable”, that the agent in principle is free to choose as he pleases.

2005 - Albert-Laszlo Barabasi in
“The origin of bursts and heavy tails in human dynamics”
human nature is bursty
“a consequence of a decision based queuing process”.
“when individuals execute tasks based on some perceived priority, the timing of the tasks will be heavy tailed”

People do not behave in a random manner. 8/22/2005 RGK

People with the emotional self-discipline to consistently and effectively execute a “rational optimizer” strategy are the minority, whereas a noise trader’s barrier to entry is much less. Seeds are planted by “rational optimizers”, but “noise traders”, and their market driven perception of their stored value within the market drive bubbles and crashes.

Stocks are a temporary store of value.

Stock value is a PERCEIVED value; local, temporal and transitional based on market dynamics. PERCEIVED priority is greed/gain or fear/loss.

Greed drives the market up and out of control of the “rational optimizers”, and attracting ever more “noise traders”, self organizing until critical, highly correlated, and highly susceptible to a perceived shift in value and hence a fear driven crash.

A complex dynamic system self- organizing towards criticality. At criticality, events that during “rational optimizers” time in charge would be uncorrelated become highly correlated.

The complex dynamic system self-organizing is not the market.

The market is a derivative of what is self-organizing; noise traders. Greed or fear is their perceived priority; driven by a perceived, temporal, transitional, market dynamic value.

The biggest risk is the unforseen risk. (In finance) The same event in two different time frames can have dramatically different consequences. Literally a six sigma event, or larger, or not.
COPYRIGHT 2005