The current financial crisis is often described in terms evocative of Poseidon's wrath: a wave of foreclosures, a perfect storm of market conditions, a tsunami of debt. It turns out those descriptions may be more accurate, and more useful, than other metaphors. If financial markets behave less like the stochastic, Brownian systems they are often compared to and more like nonlinear wave systems, then rogue waves can account for spikes and plunges in financial markets.
In fact, if markets do mimic nonlinear wave-like systems, then rogue waves periodically upending free markets are inevitable.
Rogue waves are large swells that occur spontaneously far out to sea, threatening even large ocean liners. While rogue waves had been observed anecdotally and even predicted mathematically for years beforehand, they weren't recorded and proved until 1995. Since then, they've been discovered in several other systems like fiber optics and microwaves. Now, Chinese researchers are positing that rogue waves can occur in financial systems, and could account for events like the 1997 Asia crisis or the current credit crisis sweeping the globe.
A nonlinear wave-like representation of markets could solve a major flaw in the primary means of modeling financial systems. The Black-Scholes model, which assigns a random, stochastic nature to equity prices, is useful on several levels, but researchers acknowledge that it doesn't account for volatility in real markets. A nonlinear wave-like model for markets proposed earlier this month allows for a variety of variables that more closely mirror real market behavior. Rogue waves, which we know to be real in other wave-like systems, could solve for the black swan events -- like the subprime mortgage debacle or savings and loan crisis -- that periodically appear as if from nowhere and shake markets to their cores.
What does it mean? By definition, understanding that rogue waves occur in financial markets won't necessarily help econophysicists predict an impending financial crisis. But it does mean that rogue waves are an inevitable part of free markets. Rather than playing the blame game, perhaps market regulators should be working out how best to keep the ship from capsizing when a rogue wave rises up before us. After all, we can't change the inevitable, but we can at least brace for impact.
BS. Until you consider the effects of:
2. "playing games" with other people's money (AIG FP)
3. pure "incompetence" and/or "ignorance" on the part of the regulators (see SEC) and
4. "stupidity" (on the part of the legislators, see Barney Frank)
there cannot be any X factors responsible for system volatility, much less major upheavals. Strong regulations and vigilant regulators will easily outpunch any theoretical physics.
oh i see, it's that simple, the weather was responsible for telling Bernie to Ponzi scheme the heck out of investors and Enron to invent fake companies. damn you weather [shakes fist]
Non linear stochastic system is a great model for financial markets.
Brownian motion is not.
What is of great interest in that in open non linear stochastic systems, as nobelist Ilya Prigogine noted, there are emergent self organizing properties coming out of this phenomenal random behavior.
Thank you POP SCI for this article. I read the paper with great interest.
I agree that this is a load of BS. Rogue operators and greedy individuals or groups are what causes the symptoms of what Rogue Waves. Oh please.