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Journal of Behavioral Finance

ISSN: 1542-7560 (Print) 1542-7579 (Online) Journal homepage: http://www.tandfonline.com/loi/hbhf20

Identifying the Transition from Efficient-Market


to Herding Behavior: Using a Method from
Econophysics

Mara Jos Muoz Torrecillas, Rossitsa Yalamova & Bill McKelvey

To cite this article: Mara Jos Muoz Torrecillas, Rossitsa Yalamova & Bill McKelvey
(2016) Identifying the Transition from Efficient-Market to Herding Behavior: Using
a Method from Econophysics, Journal of Behavioral Finance, 17:2, 157-182, DOI:
10.1080/15427560.2016.1170680

To link to this article: http://dx.doi.org/10.1080/15427560.2016.1170680

Published online: 25 May 2016.

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THE JOURNAL OF BEHAVIORAL FINANCE
2016, VOL. 17, NO. 2, 157182
http://dx.doi.org/10.1080/15427560.2016.1170680

Identifying the Transition from Efcient-Market to Herding Behavior: Using


a Method from Econophysics
Mara Jos ~oz Torrecillasa, Rossitsa Yalamovab, and Bill McKelveyc
e Mun
a
University of Almera; bUniversity of Lethbridge; cKEDGE Business School

ABSTRACT KEYWORDS
We test whether detrended uctuation analysis (DFA)an econophysics methodidenties the Herding behavior; Identifying
transition from efcient-market trading to herding behavior and the rise of the NASDAQ dot.com herding; Herding-on; -off;
stock market bubble. DFA divides a time series into segments of varying lengths and then tests Dot.com bubble; Hurst
whether power-law distributions exist within the segments. A power-law distribution of stock-price exponent; Econophysics;
Detrended uctuation
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changes within a segment indicates herding behavior and the start of the dot.com bubble. The analysis
clarity of the transition indication depends on both segment lengths and segment starting dates.
Our ndings show that DFA can be used to identify the beginning of stock-market bubbles but not
the beginning of crashes.

Introduction
If we accept the reality that both kinds of trading
When does efcient-market behavior turn into herding behavior exist (Yalamova and McKelvey [2011]), then
behavior? Can the transition point be identied? Gene what is missing is any tractable method for identifying the
Famas [1965, 1970] efcient market hypothesis point in stock trading where the transition between ef-
(EMH), dating back to Bachliers [1914] random walks, cient-market behavior (EMB) and HB occurs. Of course,
has dominated nancial theorizing for more than four dramatic market crashes are obvious ends to herd-insti-
decades. In fact, Jain and Gupta produced evidence of gated bubbles. But identifying the transition point from
nonrandom walks in the form of herding by banks in EMB to HB and the beginning of bubbles remains elusive.
1987, and Lo and MacKinlay showed that stock prices The key to what is now known as resilience engineering
do not follow random walks in 1988 (p. 1279; see also against nancial engineering (Sundstrom and Hollnagel
[1999]). Not surprisingly, an alternative perspective of [2011]) is identifying the transition from efcient-market
herding behavior (HB) emerged in the 1990s (Scharf- (EM) trading to the beginning of HB and the pronounced
stein and Stein [1990], Shiller [1990], Banerjee [1992], bubbles leading to dramatic market crashes.
Bikhchandani, Hirshleifer, and Welch [1992]).1 While herding stock traders gain wealth for some
Needless to say, research about herding behavior con- period of time (Brunnermeier and Nagel [2004]), which
tinues.2 Even so, Cooper ([2008], p. 11) concludes: is a positive event, there is often considerable risk to the
Despite overwhelming evidence to the contrary, the broader community when a signicant crash follows; the
Efcient Market Hypothesis remains the bedrock of how Great Recession of 20072009 following the crash of
conventional wisdom views the nancial system. the bubble based (initially) on U.S. housing prices is the
Despite Coopers observation, HB research continues most obvious recent example. Hence, one can under-
(Maskawa [2007], Brown et al. [2008], Lillo et al. [2008], stand the concern of Sundstrom and Hollnagel and their
Choi and Sias [2009], Greenwood and Nagel [2009], chapter authors (e.g., Satinover and Sornette [Ch. 6];
Hott [2009], Elan [2010], Park and Sabourian [2010], McKelvey and Yalamova [Ch. 9]) about nancial-resil-
Mendel and Shleifer [2011], Balcilar, Demirer, and Ham- ience engineering. For the Finance community, it is one
moudeh [2013], Chen [2013], Lee, Chen, and Hsieh thing to argue about whether EMH is the predominant
[2013], Reboredo et al. [2013], Sarpong and Sibanda paradigmatic explanation of trading behavior, but it is
[2014], others mentioned later). something else again to accept that both EMB and HB

CONTACT Bill McKelvey mckelveybill1@gmail.com; bill.mckelvey@anderson.ucla.edu UCLA, Anderson School of Management, 110 Westwood Plaza,
Box 951481, Los Angeles, CA 90095-1481.
Bill McKelvey is now a Professor Emeritus at UCLA School of Management.
Color versions of one or more of the gures in the article can be seen online at www.tandf.com/hbhf.
2016 The Institute of Behavioral Finance
158 M. J. M. TORRECILLAS ET AL.

exist and then look for methods of nding the switch both fractal and PL distributed. We theorize that the
from EMB to HB. emergence of a fractal structure in a stock-market time
We offer a methodnew to Finance and herding series indicates the underlying presence of HB. For our
researchfor identifying the transition point from EMB empirical conrmation we use the most popular current
to HB. Our method stems from Econophysics (West and method from econophysicsdetrended uctuation
Deering [1995], Mantegna and Stanley [2000], Chatterjee analysis (DFA)to see how well and how early it can
and Chakrabarti [2006], Rickles [2011], Sinha et al. detect the emergence of herding in the well-known and
[2011]), a eld that has developed in parallel with herd- obvious bubble-build-up of the NASDAQ Composite
ing research and originated circa 1990. Unlike EMH, (more than 3000 components) that led to the famous
however, which holds that trading behavior consists of dot.com crash starting in 2000. When it peaked at 5,132
random movements around the mean, that is, the ef- on March 10, 2000, the NASDAQ was 500% above its
cient-market price, and may be researched via Gaussian 1995 level; after it crashed it dropped to 1,185. At its
statistics, econophysicists start with Levy, Pareto, and peak the herding bubble was $4.4 trillion higher than
power-law (PL) (long-tailed) distributions. Their per- after the crash (Goldfarb, Kirsch, and Miller [2007]). We
spective ts best with the so-called fractal nance use this NASDAQ time series (starting January 4, 1993)
school: Peters [1994], Sornette [2003], Malevergne and for two reasons: (1) It was dominated by the initial trad-
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Sornette [2005], Jondeau, Poon, and Rockinger [2007], ers speculation on the growth of a new industry (dot.
and Calvet and Fisher [2008]. com rms) and ended in a dramatic crash and loss of
Fractal nance builds from Mandelbrots and the econ- value, and (2) it is a much-less random mix of rms than
ophysicists discovery that many, if not all, stock-market is true of the S&P or Dow Jones indices.
time series are fractal or multifractal; that is, the thou- We nd that: (1) By December 1994, dramatic empiri-
sands of short sequences of rising and falling stock prices cal evidence indicates that HB exists among NASDAQ
have more-or-less the same underlying causal dynamics traders and that the Hurst exponent, H, continues as a
and appearance as the smaller number of larger price rises solid indicator of the presence of HB thereafter; (2) The
and falls, and even a major longer-lasting bubble and earliest indications of HB occur before there is any
more dramatic crash. A variety of studies now show that meaningful evidence that a bubble is about to begin; (3)
price dynamics in various Indices show fractal structures.3 By November 1995, eight strong signals appear indicat-
Recently, Yuan, Zhuang, and Liu [2012] found that price ing that the transition from EMB to HB has occurred;
and volatility are correlated in stock markets. (4) Although DFA appears to be a useful method for esti-
Said differently, the many small-scale price move- mating H and hence for identifying HB, segment lengths
ments have the same geometric pattern as the fewer, but and starting dates are critically important; (5) DFA does
larger, bubbles and crashes. This is often referred to as not appear to be a useful method for identifying the
self-similarity (Song, Shlomo, and Makse [2005]) and beginning of an impending market crash; and (6) The
fractality/multifractality (Borland et al. [2005], Barunik dilemma is that although shorter segments offer earlier
et al. [2012], Siokis [2013], Sensoy [2013], Wang and Xie evidence of HB, they are also inconsistent in that they
[2013], Suarez-Garcia and Gomez-Ullate [2014]). A PL also show that herds can be on and off in HB as the
distribution of stock-price changes appears as a straight market time series progresses.
line if plotted using log X- and Y-axes; that is, it takes the We begin with short denitions of market dynamics
form of a rank/size expression, F N b, where F is fre- as dened by EMH (Fama [1965, 1970, 1998]). Next, we
quency, N is rank (the variable), and b, the exponent, is focus on how markets transition from efcient markets
constant. In cases of multifractality b varies with scale. (EMs) to bubble-build-ups and crashes. Following this,
We begin by pointing to the reality that HB is also we introduce econophysics and dene key elements,
fractal because herds mirror social inuence patterns that including fractals and PLs. Then we briey review the lit-
are networks of inuences in which some nodes (traders, erature using HB to explain bubbles in stock markets,
ofces, banks, rms) have rather pervasive inuence; also making the case that herding (rule-based trading
many other nodes are just lone followers in the herd. It is and imitation) accelerates in complex information envi-
now well known that networks are fractal structures;4 as ronments when gathering or processing information is
described in more detail later. To date, however, we have costly (Yalamova and McKelvey [2011]). More speci-
yet to nd any network-based study that actually tries to cally, we theorize that herding emerges from social net-
identify the transition point from EMB to HB. works, which appear as Pareto and PL distributions.
As we elaborate below, since complex herd networks From this base, we argue that the most popular method
of market participants synchronize their trading in a from econophysics, DFA, becomes a valid means for
bubble-build-up regime, stock-market time series are identifying stock-market transitions from EMB to HB
THE JOURNAL OF BEHAVIORAL FINANCE 159

and bubble build-ups toward the crash point. We apply Introduction to econophysics
DFA analyses to the NASDAQ doc.com bubble and
Rosser [2008] notes the long historical rooting of eco-
crash time series from January 4, 1993, to July 26, 2002.
nomics in physics. What makes econophysics different,
The DFA method shows that HB denitely exists during
however, are two key elements: (1) Its strict focus on
the doc.com bubble but evidence of HB depends on just
empirical ndings about databases and (2) its emphasis
how the DFA method is applied. A conclusion follows.
of Levy and Pareto distributions and scalability instead
of statistical mechanics, marginalism, and Gaussian sta-
From the efcient market hypothesis tistics. Though early PL discoveries date back to Pareto
to econophysics [1987], Auerbach [1913], and Zipf [1929, 1949], the
term econophysics was neologized by Eugene Stanley
In this section, we start with a quick reference to Eugene
in 1995 at a conference on statistical physics in Kolkata,
Famas [1965] well-known efcient market hypothesis
India. Since then econophysicists have discovered an
and then turn to econophysics, which abandons Bache-
array of ndings about PL-distributed economic phe-
liers [1914] view of stock markets as random walks in
nomena. Instead of nding that economic phenomena
favor of Pareto [1897] long-tailed distributions, fractals,
invariably trend toward equilibrium, they nd all kinds
and PLs. Specically, we focus on the transition from
of ndings to the contrary, as indicated in the works
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EMB to bubble-build-ups (see also Yalamova and


listed below.
McKelvey [2011]).
While the econophysics ndings are mostly empirical,
the theoretical bases for explaining why PL distributions
Efcient markets exist in nancial economics dates back to Mandelbrots
works of 1963 and 1983.7 Some of the empirical studies
Classic nancial economics dates back to three dominant
focusing more specically on nancial economics and
nance paradigms, the efcient market hypothesis
markets are:
(EMH; Fama [1970, 1998]), the capital-asset pricing
 Returns in nancial markets: Mantegna [1991],
model (CAPM; Sharpe [1964], Lintner [1965], Black
Gopikrishnan et al. [1999], Sornette and Johansen
[1972]), and the Black-Scholes [1973] options-pricing
[2001], and Stanley, Plerou and Gabaix [2008].
model. As Mandelbrot and others have noted for deca-
 Economic shocks and growth rates: Canning et al.
des, transitions from efcient markets to correlated
[1998], Stanley, Amaral, and Plerou [2000],
trader behaviors and bubble-build-ups to market crashes
Ormerod and Mouneld [2001], Podobnik et al.
occur far more often than expected (Mandelbrot [1963,
[2006], and Redelico, Proto, and Ausloos [2008].
1968, 1983], Lo and MacKinlay [1988], Peters [1994]).
 Stock market volatility dynamics: Arneodo, Muzy,
Even so, according to Fama [1998], until a new and bet-
and Sornette [1998], Muzy, Bacry, and Arneodo
ter paradigm is put forth, one cannot criticize EMH/
[2001], Ellis and Hudson [2007], Kang and Yoon
CAPM. Fama reduces behavioral nance and trading
[2007], and Jiang et al. [2010].
dynamics to anomalies and over-/under-reaction epi-
 Detecting stock market bubbles and predicting
sodes that are normally distributed and irrational. By
crashes: Grech and Mazur [2004], Couillard and
now, however, additional evidence has become available
Davison [2005], Sornette and Zhou [2006], Mas-
showing that markets oscillate between efcient market
kawa [2007], Alvarez-Ramirez et al. [2008], Czar-
behavior and nonrandom fractal behaviors.5
necki, Grech, and Pamula [2008], Du and Ning
The Economist ([2009], p. 70) observes that we now
[2008], Eom et al. [2008a, b], and Chen [2013].
know that the 25-year Great Moderation period has
 Using big data to anticipate early warning signs:
ended, in which macro- and nancial economists blithely
Preis, Reith, and Stanley [2010], Balcilar et al.
presumed that their independent, identically distributed
[2012], Bordino et al. [2012], Preis et al. [2012], Ala-
(i.i.d.), normal-distribution assumptions of efcient-mar-
nyali, Moat, and Preis [2013], Moat et al. [2013],
ket trader and asset-pricing behaviors and consequent
and Preis, Moat, and Stanley [2013].
theoretical and quantitative models offered inevitably cor-
rect views of real-world market behavior. The Economist
continues by observing that the Long-Term Capital Man-
Dening fractals and PLs
agement debacle and the 20072008 liquidity crisis both
demonstrate just how quickly supposedly uncorrelated Econophysics main contribution is the empirical discov-
asset-price movements can become highly correlated, ery of just how often non-Gaussian distributions are the
leading all traders toward the same buy/sell motivations, best descriptions of socioeconomic behaviors by self-
which then leads to a market bubble and crash.6 organizing agentspeople and social systems, stock
160 M. J. M. TORRECILLAS ET AL.

traders, stock markets, and nancial systems. Key ele- manufacturing rms in the United States show a fractal
ments are fractal structures, PLs, and scale-free theory. structure.8
In his opening remarks at the founding of the Santa Fe Since PLs mostly appear to be the result of self-organi-
Institute, Gell-Mann [1988] emphasized the search for zation, they often if not always signify active self-organi-
scale-free theoriessimple ideas that explain complex, zation processes at work maintaining some kind of self-
multilevel phenomena. Brock [2000] goes so far as to say organized criticality9 (Bak [1996]). Thus, Ishikawa
that scalability is the core of the Santa Fe visionno [2006] shows that PLs represent adaptive and changing
matter what the scale of measurement, the phenomena industries as opposed to static ones. Podobnik et al.
appear the same and result from the same causal dynam- [2006] show PLs in the stock markets of transition econ-
ics. Gell-Mann [2002] concludes his chapter, What is omies. The Dow Jones market capitalizations of the 30
Complexity? with a focus on scalability in living largest U.S. publicly traded rms show a PLagain, evi-
systems. dence of fractals when traders are free to buy and sell as
they wish (Glaser [2012]).10 Iansiti and Levien [2004]
show that the software industry is the most resilient
Fractals
across the 2002 dot.com bust. Compared to the chemi-
Consider the cauliower. Cut off a oret; cut a smaller
cals, machinery, and utilities industries, Zanini [2008]
oret from the rst oret; then an even smaller one; and
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and Glaser [2012] show the software industry to be


then even smaller, and so on. Despite increasingly
much more Pareto distributed.
smaller size, each smaller oret performs the same func-
Scale-free theories aim to explain scale-free causal
tion and has roughly the same design as the oret above
dynamics. Newman [2005] and Andriani and McKelvey
and below it in size. This feature denes it as fractal.
[2009] offer extensive discussions and descriptions of
Fractals can result from mathematical formulasas
many scale-free theories. Space precludes pursuing this
shown in Mandelbrots Fractal Geometry [1983]. We are
topic here.
more interested in fractal structures that stem from
adaptive processeslike the cauliowerin biological,
social, and nancial contexts. In fractal structures the
Using PL distributions to identify HB
same adaptation dynamics appear at multiple levels.
McKelvey, Lichtenstein, and Andriani [2012] cite 19 We now turn to review the literature on HB by
studies showing adaptation-based predator/prey fractal Bikhchandani and Sharma [2001] and Hirshleifer and
dynamics. Zanini [2008] argues that the same effects Teoh [2003] and update them. Next we point out that a
hold for merger and acquisition activities in business number of studies show that herding is based on social
niches. and/or observational networks and, furthermore, that
Fractal structures are often indicated by PLs. The networks are frequently PL distributed. These set up PLs
econophysicist Barabasi [2002] connects scalability, frac- as a means for identifying the beginning of herding-
tal structure, and PL ndings to social networks. He based stock-market bubbles, which gives us a basis for
shows how networks in the physical, biological and social using the DFA method to identify the transition from
worlds are fractally structured such that there is a rank/ EMB to HB, that is, identify the beginning of stock-mar-
frequency effectan underlying Pareto distribution ket bubbles.
showing many sparsely connected nodes at one end and
one very well connected node at the other. For example,
if plotted on a double-log graph, the Pareto-distributed Characterizing herding behavior
progression of increasing numbers of connections from,
The study of herding behavior in stock markets dates
say, small airports to giant ones like Heathrow and
back to Jain and Gupta [1987] and Lo and MacKinlay
Atlanta, appears as a negatively-sloping straight line.
[1988]. By 2001 Bikhchandani and Sharma cite 51 works
discussing herding behavior in connection with stock
PLs markets, traders, analysts, investors, mutual fund manag-
A well-formed Pareto rank/frequency distribution plot- ers, and so on. They mention information-based herding
ted in terms of double-log scales appears as a PL distri- and cascades as well as reputation- and computation-
bution. The now famous PL signature dates back to based herding. Despite all their citations, the authors
Auerbach [1913] and Zipf [1929, 1949]. Andriani and conclude that in developing countries the evidence
McKelvey [2007, 2009] list roughly 140 kinds of PLs in suggests that investment managers do not exhibit signi-
physical, biological, social, and organizational phenom- cant herd behavior. They suggest herding is more likely
ena. Stanley et al. [1996] and Axtell [2001] nd that in emerging markets. They also conclude that empirical
THE JOURNAL OF BEHAVIORAL FINANCE 161

studies are not very accurate in identifying true herding Research about the presence and rationales for herd-
behavior. ing in nancial markets has continued since the Hirshlei-
Hirshleifer and Teoh [2003] conduct a second even fer and Teoh review.11
more comprehensive review, citing some 165 works Although Bikhchandani and Sharma [2001] cite 51
focusing on nance-relevant herding. Their focus is nance-related herding papers and Hirshleifer and Teoh
on convergence or divergence brought about by actual [2003] cite 165 similar works, they primarily focus on
interactions between individuals (p. 27, their italics). identifying HB after it exists, and then argue about
Hirshleifer and Teoh argue that convergence in buy/sell whether HB is rational or irrational. More recently
behaviors can be due to: research is emerging that empirically connects herding
 Network-based payoff externalities; to changes in stock markets (e.g., Gleason, Lee, and
 Dissidents sanctioned by authorities such as Mathur [2003], Gleason, Mathur, and Peterson [2004],
dictators; Blasco, Corredor, and Ferreruelaa [2010, 2011], Chiang
 Personal preferences for buying one stock versus and Zheng [2010], Demirer, Kutan, and Chen [2010],
random others; Demirer and Ulussever [2011], Al-Shboul [2012], Balci-
 Specic information becoming available about lar, Demirer, and Hammoudeh [2013], Chen [2013],
which stock is to be preferred; and Gebka and Wohar [2013], Kukacka and Barunik [2013],
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 Observing the buy/sell actions of other people. Bohl, Klein, and Siklos [2014], Demirer, Kutan, and
Observational buy/sells can be further differentiated: Zhang [2014], Sarpong and Sibanda [2014], Yao, Ma,
 Herding together or dispersing apart; and He [2014]).
 Buy/sell decisions based on observing what other Nowhere in this literature, however, do we see any
traders are doing; empirical method proposed or used that actually identies
 Rational observations (Bayesian inference) as the transition point between EMB and HB, that is, the
opposed to seeming irrational behaviors; and beginning of HB; a recent exception is Domino [2011].
 Information cascades, which are buy/sell decisions
based on what more and more other people appear
Herding viewed from other disciplines
to be doing.
Given Hirshleifer and Teohs ndings that most Rook [2006] takes the position that herd behavior, how-
nancial economists have concluded that herding behav- ever, cannot be fully understood from a single perspec-
ior is basically irrational, they offer a set of reasons why tive alone (p. 75). Economists focus on choices herding
rational individuals abandon their own private informa- produces, especially those related to long-term effects
tion about fundamental values and, instead, jump tem- and benets obtained. Rook also notes that although
porarily on the herding bandwagon ([2003], p. 32): economists picked up the social-network approach in
 Idiosyncrasy: Increasing numbers of traders fol- the 1970sinuenced by the sociologist Granovetter
low a few initial buy/sell signals; [1973]he also says that the core assumptions underly-
 Fragility: By the time a clever initiating idea loses ing [economists use of] the network effect were the exis-
its captivating luster the network-based cascade of tence of complete information and rational actors
buying/selling has taken off; (p. 79).
 Simultaneity: Endogenous or exogenous circum- Psychologists, on the other hand, study motivations
stances causing buy/sell delays create tensions that underlying herding behaviors that emerge. Rook con-
nally dissipate resulting in chain reactions, stam- cludes: In sum, herd behavior in social psychology was
pedes, or avalanches as traders then rush to initially understood as an irrational and unconscious
jump on board the bandwagon; process. He ends his article, by advocating an
 Paradoxicality: Traders in cascades simply ignore integrative economic psychological approach to herd
countervailing information as long as the herd behavior. An integrative economic psychological
appears to keep growing; and approach could yield detailed insights into the accuracy
 Path dependence: Positive-feedback dynamics of motivations underlying individual and group deci-
based on random, insignicant initial buy/sell sions to partake in herd behavior. It thus not only helps
events give rise to increasing payoffs which then in assessment of the ways in which decision makers
become so attractive that traders get locked-in; that should deal with herding pressures within institutions
is, they are more reluctant to jump off the band- but also in the estimation of how much institutions could
wagon (Arthur [1989]). The positive-feedback ratio- benet from either partaking in or avoiding herd behav-
nale is emphasized in more recent papers as well ior (p. 91; our italics). For a very psychological review of
(Hott [2009], Jeon and Moffett [2010]). trading behavior, see Birau [2012].
162 M. J. M. TORRECILLAS ET AL.

Not unsurprisingly, we nd that various authors have, then why not me? Local interaction effects on herding
indeed, been studying just what Rook concludes; they are also found by Cajueiro and De Camargo [2006].
have taken a more institutional perspective. Cooper Maskawa [2007] uses a virtual market to show that
et al. [2001] present evidence showing that analysts fore- mimetic behavior of traders produces a PL distribution
casts correlate with recent stock price performance. (which we pick up on next). Given these three studies, it
Greenwood and Nagel [2009] nd that young, inexperi- is not surprising to nd that Neighbors Matter, which
enced fund managers are trend chasing and are much is the title of Brown et al.s [2008] article. They nd that
more prone to herding behavior. Finally, Choi and Sias the predilection of an individual to participate in stock
[2009] show that there is strong herding in the institu- purchases is a direct outcome of the extent to which his/
tional investment industry. They also nd six kinds of her neighbors buy stocks. Again, this points to the
herding: underlying investor ows, institutional positive importance of word-of-mouth [also word-of-web
feedback trading, attempting to preserve reputation by (Escofer and McKelvey [2015]) communication, which
acting like other managers (reputational herding), infer- is also a function of the nature of the social network peo-
ring information from each others trades (informational ple are embedded within.
cascades), and following correlated signals (investigative Maskawa [2007] also develops a virtual market to
herding) (p. 469). Hott [2009] and Jeon and Moffett show that stock-price uctuations are based on mimetic
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[2011] emphasize positive feedback. Baddeley [2010] fur- (herding) behavior. In doing this, he draws on preferen-
ther develops Rooks economic/psychological multidisci- tial attachment, a well-known scale-free theory and
plinary discussion by adding in personality, emotions, cause that gives rise to PL distributed networks (see also
and moods, as well as sociology and social interdepen- Barabasi [2002], Newman [2005])as nodes become
dence applied to herding, evolutionary biology and herd- larger they become more attractive, as in the rich get
ing instincts, and nally she uses interacting brain richer or in hub-and-spoke airports.
systems to explain HB. Many studies now show that networks are fractal
A socionomic approach taken by Parker and PL-distributed structures (DeSolla Price [1965]): collabo-
Prechter ([2005]; see also Prechter [1999, 2001]) offers a ration networks (Newman [2001]); various kinds of net-
somewhat differentbut relatedalternative to Rooks works (Moss [2002]); scale-free networks (Barabasi
integrative economic psychological approach. Drawing [2002]); industrial clusters (Andriani [2003]); moviegoer
on Shiller [1990, 2000, 2002] and Paretos sociological networks (De Vany [2003]); organizational networks
theory and nonrational instincts (summarized by Zetter- (Dodds, Watts, and Sabel [2003], Watts [2003]); director
berg [1993]), Parker and Prechter review existing herd- networks (Battiston and Catanzaro [2004]); social net-
ing theories based on: (1) social psychologyimitation, works (Csanyi and Szendro  i [2004], Hamilton et al.
fads, fashions; (2) information theorycascades, positive [2007]); shocks (Sornette et al. [2004]); alliance networks
feedback; (3) ethologyocking, migration, ants; (4) (Gay and Dousset [2005]); network dynamics (Powell
econophysicschaos theory, self-organized criticality, et al. [2005]); company networks (Souma et al. [2006],
fractals; and (5) medical modelsinfection, disease con- Chmiel et al. [2007]); online networks (Mislove et al.
tagion. They emphasize the impact of uncertainty on [2007]); interrm relationships (Saito, Watanabe, and
traders; prerational aspects of brain functioning (Paretos Iwamura [2007]); degrees of connectivities (Santiago and
six nonrational instincts), unconscious mental processes Benito [2008]); investment networks (Song, Shlomo, and
that underlie investment decisions; and the dominance Makse [2009]); communication ability (Zhai, Yan, and
of endogenous causality. Socionomics is based on evolu- Zhang [2013]); nancial markets (Nobi et al. [2013]);
tionary theory in that herding developed via evolu- stock-based networks (Hu, Qi, and Wang [2013]); eco-
tion to enhance survival (p. 6). In short, socionomics nomic sectors (Hu, Yang, Cai, and Yang [2013]; and
emphasizes that herding is a humanmarket trader buyer-supplier networks (Mizuno, Souma, and Wata-
survival instinct. nabe [2014]). A different kind of study showing how
communications among people form a PL distribution is
by Gerow and Keane [2011]; they analyze nancial com-
PL distributions of social and/or observation
mentaries in newspaper websites.
networks
Using a well-designed agent-based computational
We begin this section by focusing on three recent studies model initially calibrated to reproduce Gaussian-distrib-
showing the extent that stock-market participation is a uted EMH behavior in their model stock market, Lamba
direct function of social networking. Hong, Kubik, and and Seaman [2008] ndusing the DFA methodthat
Stein [2004] nd that social interaction does indeed lead when they characterize some agents with a threshold-
to stock market participation. If my friends are doing it, type herding tendency, the few agents initial tendencies
THE JOURNAL OF BEHAVIORAL FINANCE 163

to copy each others trading behavior eventually spreads we point to: Yalamova [2003, 2010]; Gneiting and
to the point where a PL distribution appears and the H Schlather [2004]; and various others.14
exponent reaches 0.86 (dened in the following section). What seems strange is that we do not nd any
Lamba and Seamans results follow the classic philoso- empirical studies (in any discipline) that actually
phy of sciences counter-factual conditionali.e., If X attempt to identify the transition between EMB and
were to occur, Y would occur (Bennett [2003]). In Sec- HB as a way of identifying the beginning of stock
tion 3 we develop a theoretical basis for using PLs to market bubbles, let alone as a method from econo-
indicate HB. In counterfactual language, our research physics (or any other discipline) to do so. While there
design tests the following sequence: If PL-distributed are many studies nding multifractality and multiscal-
trading behavior were to exist then HB would exist and ing extending across multiyear nancial time series,
then a stock-market bubble would emerge over time. none of them attempts to identify the emergence of
We now develop our rationale for using the DFA the rst fractal in a nancial time series, which would
method of identifying the beginning of HB. The logical be the rst indication that EMB has switched to PLs,
sequence of our analysis is, therefore: fractal structure, and HB. All the studies attempting
1. HB causes the transition between EMs and bubble- to predict crashes aim to identify the end of bubbles,
build-ups to crash points. not their beginning. In reality, stock-market traders
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2. Social and/or observation network dynamics give dont really care about multifractality. While predict-
rise to HB. ing crashes is obviously important, there are also
3. Such networks typically take the form of PL many trader-advantages gained from identifying the
distributions. end of EM trading as it transitions into HB and bub-
4. Networking, that is, herding, creates PL distribu- ble-build-up.
tions of stock-market price movements; they Consequently, we use DFA to try to identify the
appear as rank/frequency PL distributions ranging beginning of HB and the beginning of the emergent
from thousands or more tiny price changes from stock market bubble in the NASDAQ time series starting
day-to-day or week-to-week to fewer and fewer but January 1993.
larger and larger price changes.
5. The build-up of PLs, then, becomes a usable
method for identifying the transition between the Dening the NASDAQ bubble data segment
random price-changes due to EMB versus PL We begin by noting that Greenwood and Nagel [2009]
described price-changes due to HB and thence the observe that stocks most affected by the dramatic bubble
beginning of bubble-build-ups. and crash of the NASDAQ before and after March 10,
6. We use DFA to identify the beginning of HB in the 2000, were in the Internet and technology sectors. This
famous NASDAQ dot.com bubble-build-up. said, however, they then use the price/sales ratio
(p. 241) of rms in several SIC code technological indus-
tries to further limit their NASDAQ analyses to the
NASDAQ data, bubble segment, dening Hurst
larger rms in SIC-identied technology industries.
exponent H and DFA method
They do this since they are focusing on fund managers
We begin by documenting the fact that a number of as opposed to the broader mix of traders.
econophysicists have applied various methods to stock We use the entire NASDAQ Composite, which
market analyses. Then we dene the segment of the includes more than 3,000 components. Even so, we
NASDAQ stock market we draw data from. Next we choose the NASDAQ because it is a more focused index
dene the Hurst exponent, H. Following this, we dene instead of one explicitly designed to be a random mix of
the DFA (detrended uctuation analysis) method. various kinds of rms, such as the Dow Jones and S&P
indices. At this point in time, we prefer to use a focused
index, but not zero in on a subset of specic kinds of
Trying to predict stock-market bubbles and crashes
rms. The latter seems relevant for Greenwood and
In a paper titled Multi-scaling in Finance, Di Matteo Nagels study of fund managers, but for our more general
[2007] reviews several competing methods created in search for the beginning of bubbles the Composite index
econophysics that are used to study the multifractal12 is more appropriate. Unlike Greenwood and Nagel, how-
structure of stock-market time series.13 Some econophys- ever, who focus on the timeframe of December 1997
icists, however, more explicitly zero in on trying to actu- through December 2002, we analyze the market from
ally predict the occurrence of crashes once stock-market January 4, 1993 to July 26, 2002. We try to start our anal-
bubbles have formed. In addition to studies listed earlier, yses before the dot.com herding bubble started.15
164 M. J. M. TORRECILLAS ET AL.

Dening the DFA (detrended uctuation analysis) most straightforward more recent descriptions of the DFA
method method are given by Weron [2002] and Delignieres, Torre,
and Lemoine [2005]. Details of the method they describe
At this point in time the most popular method, which we
are presented below, with some further elaborations by us.
choose, is DFA (Peng et al. [1994, 1995], Ausloos et al.
Step 1: Create a cumulative time series:
[1999]).16 After statistically testing the relative accuracies of
three competing methods, Weron [2002] concludes that
X
k
the DFA statistic turns out to be the unanimous winner y.k/ D x.i/ (1)
(p. 285; our italics). In stochastic processes, chaos theory, iD1
and time series analysis, DFA is most useful for determining
the statistical self-similarity (i.e., fractal or PL structure) of a We use NASDAQ weekly closing prices from Friday,
time-series in which the data points are stock-market price January 8, 1993 to Friday, July 26, 2002. For us, k D
changes. DFA is useful for analyzing time series in which number of weekly (total D 500) closing prices in our
changes could be PL distributed, such as social networks, NASDAQ time series, y. As noted earlier, Yuan, Zhuang,
i.e., herd-based, stock-price changes. and Liu [2012] nd that price and volatility changes are
The generalized Hurst exponent, H originated in correlated, even in multifractal stock markets.
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Edwin Hursts classic article of 1951, in which he Step 2: Create time-series segments: The cumulative
describes his studies of volatile oods and droughts time series y(k) is divided into a set of d non-overlapping
in the Nile river valley. The Hurst exponent is nonde- time-series segments (often called boxes in the DFA lit-
terministic in that it expresses what is actually erature) of equal-length n; d n D L, the total length of
observed in nature; the econophysicists all say that it the time series being L.
is not actually calculated but rather is estimated. Step 3: Calculate OLS ts for each segment: Using
Starting in 1968, Mandelbrot recognized the implica- price-uctuations within a segment, calculate the least-
tions of Hursts method of analysis for fractal repre- squares line that ts the data. This is the trend line
sentation of real-world phenomena (Mandelbrot within the segment. The example R2 values we show in
[1983]). Writing about fractal structures in all kinds Figure 1 indicate whether the uctuations within a seg-
of phenomena (Schroeder [1991], Peitgen, J urgens, ment are large or small.
and Saupe [1992/2004], Hastings and Sugihara Step 4: Detrend the cumulative time series, y(k), by cal-
[1993], Mandelbrot [2010], Wang, Ziang, and Pandey culating price-uctuation deviations above or below the
[2012], Pav on et al. [2013], Sensoy [2013], Siokis within-segment trend line for each Fridays closing price:
[2013], Suarez-Garcia and Gomez-Ullate [2014]) has v
proliferated in recent years, especially in fractal u L
u1 X
nance, as many of our foregoing econophysics cita- F.n/ D t y.k/ yn .k/2 (2)
tions indicate. H has become the predominant out- L kD1
come variable of DFA analyses.
The best originating sources of DFA are Peng et al. [1994, In this step, all price uctuations within all the seg-
1995] and Taqqu, Teverovsky, and Willinger [1995]. The ments are now represented as deviations above or below

Figure 1. Depicts how the within-segment OLS-dened trend lines differ. Shows the R2 ts of price deviations around within-segment
trend lines as well as H values for several of the 25-week DFA segments before and after the crash (Friday of week 300 is September 25,
1998; Friday of week 400 is August 25, 2000). Note that the R2 and H values are not correlated and that HB disappears in the segment
of weeks 325350; HB temporarily dissipates into EMB in this segment, which comes some three years after HB appears to have started.
THE JOURNAL OF BEHAVIORAL FINANCE 165

the OLS trend line within each specic segment. This By the foregoing process, the DFA method typically (but
computation is repeated over all time scales (i.e., all seg- not always) produces a positive sloping a plot line with
ments of all lengths) to identify F(n), the average uctua- its lower end toward the Originas illustrated in
tion within each of the d segments having similar length, Figure 2.18
n (each segment can have a different trend line). The angle of the sloping line to the X-axis gives us the
The time series is subdivided into a set of d segments, estimated19 value of H (based on a), the exponent rep-
some of which we illustrate in Figure 1 (actual segments resented in formula 3, where: n is segment length; F(n) is
are not shown, just the OLS lines within the segments): the average uctuation; c is a constant:
Figure 1 highlights the Hs of the 25-week segments (i.e.,
of length n) before and after the crash; each of the seg- F n  cna : (3)
ments has to be further subdivided into 2 subsegments,
then 4, then 8 subsegments of 12, 6, and 3 weeks each Given that the stock-market time series is fractal
(not shown) to calculate H. After OLS creates the trend Brownian motion, we obtain the estimated value of H
line for each segment, the R2 numbers indicate how close from the following equation (Delignieres, Torre, and
the price uctuations are to the trend line. Lemoine [2005]):
Step 5: Calculate H: Peng et al. [1995] place of all of
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the longer- and shorter-segment OLS-deviation values H D a 1: (4)


on the Y-axis (using the log value of the average of all
uctuations, F(n), within each of the d segments of the As one may see in Figure 2, the two sloping lines that
same length, n, as the entriessmallest segment values show the highest H values are slightly steeper than the
are nearest to the origin). They locate segment-length on other slopes. Since the several H values are more dramati-
the X-axis (using the log of segment length), with the cally different than the angles of the slopes, the econo-
shortest similar-sized segments nearest the Origin and physicists have come to focus on H as the exponent rather
the longest segment (containing all of the subdivided than a. Since the H exponent can only range between 0.0
shorter segments) out at the right-hand end of the and 1.0, the H D 0.2 and H D 0.87 are extreme values;
X-axis. By doing this they set up conditions that create although the a slopes are somewhat different, they dont
the rank/frequency distribution (if it is present in the give any indication of being extreme. An H D 0.5 is an
data) underlying all PL graphs.17 Their DFA method indication of white noise, i.e., randomness.
arranges the data such that the PL distribution will An H increasingly higher than 0.5 (econophysicists
emerge as an inverse sloping straight line if the time- call this persistent behavior) indicates the presence of
series data within a given segment are, in fact, PL fewer, but ever-larger deviations away from the OLS line
distributed. (i.e., traders intensify their herding behavior); these devi-
Because of HB, Peng et al. [1995] note that longer seg- ations result in a PL rank/frequency distribution. We
ments will typically contain larger price uctuations take this to be evidence of positive-feedback20 based HB
around the OLS within-segment trend linethat is, if in the stock market. A value of H less than 0.5 (called
the herd develops and starts collective buying and selling anti-persistent behavior) indicates a market systemati-
behaviorwhich also means that the average deviation cally reverting to the long-term mean and/or reversing
value will appear higher up on the Y-axis. When the itself more consistently than a random market, i.e., EM
time series is subdivided into many shorter segments, for traders whose frequent alternating buying and selling
example, d D 32, each segment-average is based on many keeps the market price continually approximating the
fewer price uctuations and absent HB-based positive- fundamental value of a rms stock.
feedback inuences, they will typically show much Step 6: Find optimal segment length: There is an opti-
smaller OLS deviations and, therefore, be positioned mal segment length: if they are too short (e.g., one month
lower on the Y-axis near the origin. By using the binary long) they could just show random variance; if they are
divisor and log scales, Peng et al. create the conditions too long they could also lose their unique distinguishabil-
such that the data, when plotted in a double-log graph, ity; i.e., the appearance of a strong upturn could be com-
will create the classic inverse-sloping PL straight line. As bined with strong downturn, with the result that H could
the OLS deviations in the longest segment become larger, also appear in the 0.5 range even though HB is strong
relative to the average OLS deviations in the increasing both up and down (illustrated later in Figure 5, which
number of smaller segments, the PL slope gets steeper shows that when a segment contains dramatic ups and
and H increases above 0.50. This because the probability downs in the stock chart the R2s are near zero and the
is that the longest segment will have the largest number Hs are 0.5). Steps 25 need to be repeated for different
of large price deviations away from the OLS trend line. starting dates and segment lengths to nd the optimal
166 M. J. M. TORRECILLAS ET AL.
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Figure 2. Shows the a slopes calculated for several DFA segments (shown in Figure 3). Although the a slopes appear not all that differ-
ent compared to some of the estimated H exponents (H D a 1; Hs shown in the callout boxes) are quite extreme, since the H expo-
nent is limited to a range of 0.00 to 1.00. a slopes and H exponents are shown for Figure 3 segments as follows (from top to bottom):
H D 0.76 (diamonds; row g in Fig. 3), H D 0.31 (dots; row h in Fig. 3), H D 0.49 (squares; row b in Fig. 3), H D 0.02 (triangles; row a in
Fig. 3), and H D 0.87 (crosses; row b in Fig. 3). The top two slopes are for 100-week segments; the bottom two slopes are for 25-week
segments; the middle slope is for a 50-week segment. Since the Hs are more discriminative than the a slopes, econophysicists prefer to
use Hs to identify herding.

segment length, n, and segment-starting dateas are market bubble. Furthermore, the two following observa-
clearly indicated in Figure 3. tions are worth noting:
We have an additional concern about segment length. First: Domino [2011], who uses daily price uctua-
With his model, Weron [2002] studies segment-length tions, doubles the number of data points simply by
samples ranging from 256, to 512, to 1024, to 2048 including daily opening prices as well as closing prices.
(e.g., doubling in size) up to 65,536. Obviously, for Each day has two data points, and the number of data-
statistical purposes large samples are useful. Our NAS- points in each segment is doubled. While this appears as
DAQ time series from January 4, 1993 through July 26, an advantage for using dailies, we will show later in
2002, however, contains roughly 2,500 daily closing pri- Table 2 that weekly prices are sharper indications of HB,
ces (500 weeklies) and includes the bubble and crash. If even though there are fewer of them.
we studied 10,000 daily prices we would lose our test- Second: While our use of weeklies in short segments
base of the single well-recognized NASDAQ stock- (our shortest segments have only three data points)
THE JOURNAL OF BEHAVIORAL FINANCE 167
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Figure 3. Alignment of the DFA segments of various lengths and starting dates associated with the rise and fall of the NASDAQ stock
chart during the time of the dot.com Bubble and Crash. NASDAQ Index values listed on the Y-axis (left-side); weeks listed on the X-axis;
rows listed on the right-side. Segments showing H exponent values above 0.56 are underlined and in bold. Numbers at the bottom indi-
cate the weekly progression of Friday closing prices. This graph shows how dependent the H values are on segment length and starting
date. By week 150, however, eight segments of different lengths show Hs at 0.6 or higher. Dates of each 25-week time and actual price
changes are shown in Table 1.

seems prone to random error, it is important to note that DFAKey Points: (1) We cite many empirical studies
as segments get shorter there are more of them being showing that herding exists over long periods of time in
averaged together. For example, suppose the longest seg- various market-transaction time series; (2) DFA is the
ment-length has 100 weekly data points; the shortest seg- only method we are aware of that breaks time series
ment then has only three weekly prices in it; but there are down into segments and then (3) tests for PLs within the
33 of the shortest segments; the total data points upon segments (i.e., clear indications of long-tailed rank/fre-
which the Y-coordinate is basedthat is, 3 32 D 96 C quency distributions) as evidence of HB; (4) Breaking a
4 (one segment has 4 weeklies in it)is the same as the time series down into the shortest valid segments (i.e.,
number of data points in the longest segment, 100. they have to be long enough to include a valid rank/fre-
Because of the small segment size, it is possible that each quency distribution) is the best way for identifying the
individual-segment OLS root-mean-square value could beginning of herding.
be questionable, but when 33 of them get averaged
together the total database is the same as for the longest
Results
segment. In short, the total database for each entry on
the Y-axis in Figure 2 is the same. Figure 3 shows the NASDAQs rise and fall between
The dilemma: Our objective is to try to identify the January 4, 1993 and July 26, 2002, with the peak of the
beginning of the NASDAQ bubble sometime after January market occurring on March 10, 2000. For identication
4, 1993. This creates a dilemma: (1) On the one hand, the of the beginning of HB, we begin with analyses of various
shorter the segments, the sooner we can identify segment lengths, starting at different points early on in
the beginning of the bubble (assuming, of course, that the the NASDAQ time series (after January 4, 1993), which
NASDAQ bubble is based on herding and positive feed- are also shown in Figure 3. Our objective is to see if there
back or other scale-free causes); (2) On the other, the is a combination of segment length and starting date that
longer the segment, the more shorter segments we have, offers a clear, consistent indication of when HB begins.
the more data points we have in each shorter segment, Because we are looking at a bubble-build-up and crash
the more solid is the basis for determining H, and statisti- sequence that has already taken place from beginning to
cal credibility improves. Since traders, however, are look- end, and hence the crash point is well dened, we can
ing for increased probabilities that HB has begunrather end some segments at the crash point and then take
than some kind of scientic truthshorter segments are them backward in time (see rows c, d, and h). While this
preferable, but only as long as their H results do not could only happen in real-time if all possible segment
appear to be error prone, needless to say. lengths and starting times are continuously analyzed by
168 M. J. M. TORRECILLAS ET AL.

a well-designed model (i.e., it could happen by chance), Across weeks 251300 (row b) we see H D 0.49, reect-
in this study we are experimenting with just a few kinds ing more random irregular up and down price move-
of segment lengths and starting-time congurations that ments but in the rst half (250275) we see a slight move
might offer meaningful H-based indications of the tran- toward persistence, and in the second half (276300) we
sition from EMB to HB. see a trend toward anti-persistenceH D 0.17. Finally,
1. Row a: The top line shows segments starting on in weeks 326375 (row c) we see both OLS trend lines
January 8, 1993 (the rst Friday). Each segment is showing rising price changes, but again we rst see anti-
25 weeks long; hence HB indications come much persistenceH D 0.02around what traders evidently
quicker. But their Hs are very inconsistent: some are presume are rising fundamental values in dot.com rms,
very high and some very low, and they more or less alter- but which then transform into persistent herd-driven
nate between high and low. While the segments appear speculationH D 0.75reecting a steep rise in prices
to give inconsistent indications of HB as on or off, they just before the crash.
do indicate that HB is either very strong or lying in 3. Rows d, e, and f: Segments in these rows are
waitgiven various endogenous or exogenous cues, the 75 weeks long; row d starts on January 8 and then the
herd jumps on or off the bandwagon; this idea is more segments roll forward in 25-week segments. What is
consistently reinforced as the time series progresses. amazing to us is that during the dot.com bubble build-
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2. Rows b and c: These segments are approximately up and crash, only two out of the total of 13 of these 75-
one-year (50 weeks) long; row b starts on January 8, week segments ending at or before the crash show Hs
1993. Row b segments alternate high and low early in the substantially above 0.5. Yes, one of these ends in late
sequence. But there are two high-H segments just before November 1994, the time of the earliest grouping of H >
and after the March 10 crash point, with an H D 0.54 0.5 in the various rows, and the other ends 25 week later
segment in betweenthat is, strong HB buying before in May 1996. Then there are no Hs > 0.5 in these seg-
the crash and then strong selling 25 weeks later, with ment-lengths during one of the most famous bubble
mixed buy-sell behavior from weeks 351 to 375 across build-ups? This is our rst clear evidence that segment
the crash date. Row c segments are the same length as length is critical.
the row b segments but they start 25 weeks later. Note, 4. Rows g, h, i, and j: These segments are 100 weeks
however, that just by starting 25 weeks later they show long. Row g also starts on January 8, 1993, but then each
four segments of H > 0.5 before the crash point, three of row starts 25 weeks later. To begin, observe that the rst
which have Hs 0.65 or higher. segments in rows g & h show low Hs (i.e., 0.42 and 0.31),
Viewing rows b and c together, we have the equivalent but then as the rolling Hs in segments sequentially start-
of rolling segments (for previous use of rolling seg- ing 25 weeks later progress, we see Hs as follows: 0.76,
ments see Grech and Mazur [2004] and Alvarez-Ramirez 0.63, 0.76, 0.55, 0.66, 0.63, 0.57, 0.47, 0.60, and 0.70. All
et al. [2008]). Each 50-week-long segment in one row but one H (D 0.47) are at or above 0.6 or round up to
starts 25 weeks after a segment in the other row. 0.6. This rolling series of segments rst indicates HB has
A couple segments in rows a and b give early indica- started at week 150 and then shows HB continuing past
tions that HB has been activated, but it is mostly lying in the crash point except for the one segment of weeks
wait till the time series gets to week 150, November 10, 226325 showing H D 0.47it happens to include the
1995, by which time eight segments in various rows have largest sell-off before the crash starting on March 10.
shown H roughly 0.6 or higher. But only after week 175 For reasons not obvious to us, row h shows only one
do the 50-week segments show that HB is more consis- H not much above 0.50. In contrast, rows i and j show
tently evident. The presence of HB is re-conrmed in all Hs at 0.6 or higher in all the segments ending before
various other follow-on segments that start on different the crash. Yet the segments are all of the same length
dates, as we discuss next. and are only 25 weeks different in start date. The start
To give a more graphic illustration of what underlies date is critical.
the H values in row a compared with rows b and c, we Of all the rows, i and j are the most consistently indic-
show close-up views of the price changes and Hs for ative of the start of HB and bubble-build-up. These seg-
weeks 150, 251300, and 326375 in Figure 4. The 50- ments start in 1994; they give consistent strong
week Hs and price changes (see rows a, b, and c in indications of the presence of HB during the bubble
Figure 3), respectively, are 0.59 (slight rise), 0.49 (up and build-up before the crash date. But compare row h (only
down), and 0.75 (steeply up). In weeks 1 to 25 in Figure 4 one H > 0.5) with rows i and j. Also compare the 75-
(row a) we rst see anti-persistenceH D 0.10small week long segments d, e, and f with the 100-week seg-
price changes oscillate around the OLS line, but in weeks ments in rows g, i, and j. The latter consistently show H
26 to 50, we see a sharp upward OLS lineH D 0.67. > 0.6 whereas rows d, e, and f show only two segments
THE JOURNAL OF BEHAVIORAL FINANCE 169
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Figure 4. Shows enlarged views of price-change deviations above and below the OLS-t lines inside the DFA 25-week segments (row a)
for weeks 125, 251275, and 326350 on the left and segments for weeks 2650, 276300, and 351375 on the right. The dashed lines
show the OLS ts across both left and right segmentswhich show Hs D 0.59, 0.49, and 0.75 in rows b or c of Figure 3. Figure 4b shows
price changes above and below the OLS lines, which result in H D 0.49 for weeks 251300. The left-side segments of Figures 4a and 4c
depict anti-persistencelow Hs D 0.10 and 0.02 for weeks 127 and 326350. The right-side segments of Figures 4a and 4c depict per-
sistencehigh Hs D 0.67 and 0.81 for weeks 2650 and 351375.

with H D 0.60 & 0.75 (out of 13 before the crash). Even down. Row ks time of earliest HB indication matches
though the segments are not all that different in length that showing in row-i and also in rows a, b, and d. How-
75 versus 100 weeks longboth start dates and segment ever, row k shows HB with some upward movement
lengths are critically important. Unfortunately, one can- early on in the market, but by the time the H of the third
not know which is best until the time series has moved segment is known, it is too late; it obscures the most dra-
past the closing dates of the segments. matic up and down moves in the market.
5. Row k: The 150-week segments in this row also One might think this is because H is high both before
start on January 8 and stay H > 0.5 through the 25-week and after the crash (i.e., Hs indicating strong herd buy
sell-off ending around September 25, 1998 (week 300). and sell behaviors), and the 150-week-long segment off-
Row k gives a strong and consistent indication of modest sets the values of the two high Hs. But in row d the seg-
HB in action, but the third segment drops to H D 0.44 ment three weeks before the crash shows H D 0.51 and
while the market is moving dramatically both up and the segment three weeks after the crash shows H D 0.45.
170 M. J. M. TORRECILLAS ET AL.

HB does not appear to be present shortly before and after could jump on board at this point. But H then stays
the crash. Now look at row b. Here we see three 50-week below 0.05 in these segment lengths for all of 1994.
segments with Hs at 0.59 before the peak, 0.54 (across 2. With additional segment-start timings and seg-
the peak), and 0.59 soon after. Yet, for exactly the same ment-lengths, however, doubts emerge: Rows c
time seriesweeks 301 to 450segments in rows d and through k offer no indication of herding till
k show Hs near or below 0.50. Again, segment length November 10, 1995.
makes a difference. 3. If traders kept their H analyses going by using dif-
Table 1 offers a more obvious view of when the Hs ferent segment start-times and segment-lengths,
appear, when HB starts, and how they progress. Weeks, they would eventually see that by November 10,
dates, and changes in stock prices appear in the left-most 1995 (week 150), HB is present, as indicated by
columns. Various Hs are shown, though we omit rows d, e, segments in rows a, b, d, i, and k.
and f. Looking at the bottom of the columns representing 4. After 1995 we see a variety of H > 0.5 indications
rows a and b, we see quick and short indications of popping up here and there in most of the rows,
Hs > 0.5. To the right and a bit higher in the table, arrows though the 75-week segments show only two H >
highlight the rather obvious progression of Hs > 0.5 going 0.5 before the crash.
toward the upper-right. At the lower-left the Hs are on and 5. Look at Figure 3 from week 251 to week 300. This
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off, suggesting HB is on and off (analogous to the on/off period shows price uncertaintyone strong buy-
defensive or aggressive behavior of a buffalo herd), indicat- segment and two strong sell-segments. Row a
ing that traders are uncertain about whether HB is really shows Hs of 0.42 and 0.17 in this period; row b
worth the risk or not. But then, as the 100-week segments shows 0.49 for the 251300-week segment. But
go up toward the right, Table 1 indicates the transition row b also shows H D 0.68 & H D 0.59 in the seg-
from EMB to consistently present HB. The arrows highlight ments before and after this one. The H values go
just how consistent HB is as the bubble develops. The dot- random in this time period, the herd is uncertain;
ted-line arrow indicates when the crash occurs. This table but starting at week 300 the herd re-activates; the
indicates how rational it would be for traders to apply bubble really takes off with various segments
DFA along with continuous computational methods for showing higher Hs.
zeroing in on the shortest viable segment-length and start- 6. The most pronounced buy signals show up in
ing date for early detection of HB. rows c, g, i, and j. In row c, we see high Hs in seg-
Boiled down, our DFA results are:21 ments going from week 176 to week 375. In rows
1. By the end of 1993 (week 50), rows a and b give g, i, and j the segments also show a continuous
early H-indications that HB is present. A trader buy signal from week 176.

Table 1. Dates are added to the weeks of the NASDAQ bubble shown in Figure 3. Price changes are shown along with the DFA seg-
ments. Arrows highlight the H values indicating the presence of HB. The beginning of HB appears in eight segments by week 150
(November 25, 1994). The dashed arrow indicates the time of the crash (March 10, 2000). In the segment-lengths shown in this table
(shaded), there is an indication of when the bubble starts and that HB continues consistently until the point of the crash. The presence
of H values at 0.6 or higher is most consistent in Rows i, j, and k, which show the 100-week segments.
Week Date Price Changes Row-a Row-b Row-c Row-g Row-h Row-i Row-j Row-k

500 26/7/02 65.93 0.5 0.4 0.5


475 1/2/01 44.23 0.4 0.4 0.5
450 10/8/01 306.04 0.2 0.6 0.6 0.4
425 16/2/00 1808.95 0.6 0.3 0.5
400 25/8/00 1005.94 1 0.5 0.5
375 3/3/99 2045.17 0.8 0.8 0.7
350 10/9/99 467.89 0 0.6 0.6
325 12/3/98 806.29 0.7 0.7 0.5
300 25/9/98 76.65 0.2 0.5 0.6 0.6
275 3/4/97 188.56 0.4 0.5 0.6
250 10/10/97 529.74 0.9 0.7 0.7
225 18/4/96 0.79 0.4 0.7 0.6
200 25/10/96 19.84 0.8 0.5 0.8
175 3/5/95 139.57 0.2 0.5 0.6
150 10/11/95 192 0.7 0.9 0.8 0.6
125 19/5/94 119.55 0.9 0.5 0.3
100 25/11/94 8.27 0.4 0.5 0.4
75 3/6/93 16.85 0.4 0.4
50 10/12/93 65.93 0.7 0.6
25 18/6/92 12.24 0.1
THE JOURNAL OF BEHAVIORAL FINANCE 171

7. BUT, by the time the Hs indicate sell the market crash show H D 0.81 & 0.33. The 50-week segments
has lost 3,000 points. Around the crash point, the with end dates at weeks 350 and 450 both show
Hs either indicate H at roughly 0.5 (dened as ran- Hs D 0.59. The 100-week segment starting 50 weeks
domness by the econophysicists), or, as in rows a before and ending 50 weeks after the crash shows
and b, indicate consistent HB, but not that the H D 0.49. The 150-week segment from weeks 300 to
herd switches from herd-buying to herd-selling. 450 shows H D 0.44. The Hs for the foregoing differ-
8. Is there an indication about when to sell? Six of the ent segment-lengths and starting dates offer no useful
11 rows show HB pretty much disappearing right information that a major crash is about to occur. As
before and after the crash point. Note, however, seen in Figure 1, the herd temporarily returns to
that there are also Hs > 0.5 as HB appears when anti-persistent behavior during periods of investor
more and more traders start selling. Our DFA uncertaintyweeks 326350but then regains its
analysis does not give a strong indication for stay- herd mentality, as we see happening as traders go
ing in long enough to take advantage of the steep from week 351 through the three following segments
rise after September 1999 (week 350), nor when to to week 425 (see Figure 1). Note that in the 376400-
bail. week segment we see the herd making wild buy/sell
9. Note that the last segment in row k shows H D moves that produce a very low R2 but a very high H
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0.44 from 75 weeks before the crash to 75 weeks during this period of uncertainty after the crashthe
after. Why? Is it a combination of a herds strong herd still stays connected but cannot decide whether
buy and then strong sell decisions, both within to keep buying or start sellingso it does both as a
the same segment? Now look at row d for the herd.
same time period. Here we see that H is 0.51 three Some readers will wonder why we use weekly price
weeks before the crash and 0.45 for the three weeks uctuations instead of daily uctuations. In Table 2
after. But in contrast, rows a, b, e, and i show H we show some comparative analyses of the more
0.6 after the crash. Depending on segment-length extreme H values to see if differences appear and are
and start dates of the segment sequences, H worth taking into account. As our sampling of weekly
appears to show, or not to show, the existence of versus daily closing prices indicates, the Hs are
HB before and after the crash. mostly less extreme for daily price uctuations than
10. Our DFA analysis does offer various indications of for weeklies. If the herd is uncertain and is bouncing
the beginning of the dot.com bubble and continu- back and forth between buying and selling, the OLS
ing HB, but DFA does not offer any clear predic- deviations more or less offset each other, thereby
tion of when the Crash starts. bringing weekly H values away from really high or
The 25-week segments detailed in Figure 1 show low indications of HB. Alternatively, if the herd gen-
Hs of 0.69, 0.02, & 0.81 just before the crash and erally leans toward only buying (or only selling) on
0.97, 0.64, and 0.21 just after. Figure 5 details H val- the ve week days, the weekly closing price would
ues in longer segments just before and after the crash show a more dramatic deviation away from the H D
point. The 50-week segments just before and after the 0.5 value. Given these comparative results, we believe

Figure 5. Shows the OLS t R2s and H exponent values for the weeks before, during, and after the crash starting the week after March
10, 2000. The 100-week segments show a consistent H > 0.5 leading up to the crash. The three segments extending before and after
the crash show H values near 0.5which econophysicists dene as random white noise. But in this Figure the H near 0.5 is obviously
a combination of strong herd buying and selling (see also the 25-week segment Hs in Figure 1). DFA H values do not offer any obvious
indications of the impending crash.
172 M. J. M. TORRECILLAS ET AL.

Table 2. Shows the difference in H values for daily versus weekly closing prices in the NASDAQ Index for selected segment lengths pre-
sented in Figure 3. The upper table consists of only segments in Row a. The lower table shows differences in daily vs. weekly H values
for some of the segments in rows h, i, and k. Note, that the Hs for weekly prices are mostly further away from H D 0.5 than the dailies;
and that the only substantial conicting difference appears in the shaded segment.
Segments in Row a.
Segments in Row a.

Weekly H D 0.67 H D 0.93 H D 0.66 H D 0.69 H D 0.80 H D 0.39 H D 0.92 H D 0.02 H D 0.97
Daily H D 0.50 H D 0.68 H D 0.55 H D 0.70 H D 0.60 H D 0.50 H D 0.70 H D 0.20 H D 0.37

Segments in Rows i, j, and k.

Weekly: Row h: H D 0.31 Row i: H D 0.76 Row k: H D 0.57


Daily: Row h: H D 0.42 Row i: H D 0.62 Row k: H D 0.60

our choice to use only weekly prices in Figure 3 is to have multiple price-changes over time for the PL dis-
validated. tribution to materialize. Until this occurs, it is impossible
However, in the last segment in the row a section of to know what level H is at by using the DFA method.
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Table 2, H shows a dramatic shift from the weekly H D


0.97 to the daily H D 0.37 (i.e., from persistence to anti-
persistence). Switching from weeklies to dailies shifts the Comparison to recent alternative big data
H from indicating a strong presence of HB to minimal methods
presence. We included the 25-week segments because,
obviously, traders would like to get the earliest indication Preis, Reith, and Stanley [2010] draw insights from
of HB as possible. However, they are more questionable search engine query data (p. 1). Balcilar et al. [2012]
in their results. As much as traders might like really early specically conclude that global shocks signicantly
indications of HB presence, the 25-week segments may contribute to investor herding (p. 1). Bordino et al.
be suspect in the quality of information they provide. [2012] nd that web search queries can predict stock
In summary, there are two H-clues that HB has market volumes (p. 1). Moat et al. [2013] nd that loss
started sometime in 1993, but the earliest this is known averse individuals are more apt to rely on Wikipedia
is the end of 1994. The earliest corroborated evidence of searches to anticipate falls in stock-market prices. Preis,
a bubble build-upbased on ve segments showing H  Moat, and Stanleys [2013] use of Google searches to see
0.57appears in November 1995. Because of the seg- whether big data style information offers advance indi-
ment length requirement, it does take some passage of cations of dramatic stock-market changes. In Figure 6
time before HB can be indicated simply because we have we show Preis et al.s comparison of the dramatic rise in

Figure 6. Shows Figure 1 from Preis et al. [2013], which is positioned above their gure 2. The dashed line shows the 2009 dates of both
gures line up. In Figure 2 we see that debt based on Google searches starts rising before the post-crash rise in the DJIA starts, hence
offering some predictive value to traders. But it also shows that the debt indicator rise (dark grey; in blue online) pretty much at-lines
after 2010, even though the DJIA keeps rising.
THE JOURNAL OF BEHAVIORAL FINANCE 173

the DJIA after the collapse of stock markets2008 to sequentially by 2 down to the shortest time series chosen.
2009 (upper graph)with an increase in Google searches In our case this consists of a series of experiments of ini-
using the search-term debt (lower graph). It is obvious tial segment lengths ranging from 150 weeks down to
that there is a steep increase in Google searches before 25 weeks (the latter are further binary subdivided to seg-
the DJIA hits the bottom and starts back up. Thus the ment-lengths of 3 weeks).
Google search data offer uptick information before the We cite many studies showing (1) that long-tailed
uptick begins. In contrast, however, the Google search Pareto and power-law (PL) distributions are associated
graph more or less at-lines after 2010the Google- with the appearance of nonlinear changes in stock prices,
search data tell us that the DJIA will stay around and (2) the links among nodes in social and business net-
10,000even though the DJIA keeps rising. works often appear Pareto and PL distributed. These
The key difference between Preis et al.s method and studies suggest using DFA to connect the rise or fall of
our use of DFA is that they draw from a database outside HBr with changes in stock prices. DFA calculates a
of the stock market, whereas we apply DFA directly to within each segment; the higher is a the more dramatic
stock trader buy/sell decisions to nd evidence of herd- is the PL distribution of stock prices with the segment.
ing embedded explicitly in stock buy/sell decisions. The The slope of the a plot line in a graph sets up an estimate
methods are obviously different, but more research is of what econophysicists call H, the Hurst Exponent,
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needed before one can decide which one is a more useful which we use as a measure of HB intensity.
and reliable predictor. Their method gives a strong indi- Our results offer mixed signals: (1) Different segment
cation of the forthcoming start of the bubble some four lengths and starting dates produce varying indications of
months in advance. Our use of DFA (see rows i and j in strong or weak HB, as shown in Figure 3 and Table 1. (2)
Figure 3) offers information that herding is developing The shortest segments periodically offer the strongest H
150 weeks and more, before the sharp upturn begins. values, but are also the most inconsistent. (3) Our earliest
One possibility is that big data searches cause HB, consistent HB indication (coinciding with the visual indi-
which then causes bubbles. cation of the beginning of the bubble build-up; that is,
the rise in the stock chart starting in early June 1994
[week 75]) appears in segments ending on November 10,
Conclusion
1995 (week 150). (4) This is the date when 5 HB signals
Our review of the herding literature in nance shows no (i.e., Hs > 0.6) at the ends of segments of varying lengths
evidence that any empirical method has been applied to all coincide to offer the strongest indication of HB pres-
directly identify the beginning of herding behavior (HB) ence. (5) This high HB indication stays most consistently
in stock markets and thereby the transition from efcient at H > 0.6 in the rolling series of 100-week long seg-
markets (EM) to HB. Our review also shows that HB has ments starting at the end of 1993 (week 50) and rolling
just barely seeped into Physica A; Yook and Kim [2008] forward (in 25-week jumps) until one of them ends on
and Kukacka and Barunik [2013], with no application of the date of the crash (March 10, 2000). (6) As an indica-
DFA to study HB, have not attempted to identify the tion of the importance of choosing the best segment
transition from efcient markets behavior (EMB) to HB. length, the rolling series of 75-week long segments shows
However, HB studies appear more frequently in interna- only two H  0.6 out of a total of 13 before the crash.
tional studies, such as Venezia, Nashikkar, and Shapira Finally, (7) DFA does not offer an obvious prediction of
[2011], Al-Shboul [2012], Shih et al. [2012], Bhaduri and the NASDAQ crash.
Mahapatra [2013], Garg [2013], Gebka and Wohar Several qualications need mentioning. Our data
[2013], Lin, Tsai, and Lung [2013], Bohl, Klein, and source is the NASDAQ leading up to the dot.com crash.
Siklos [2014], Demirer, Kutan, and Zhang [2014], We explicitly use NASDAQ for testing whether DFA is a
Sarpong and Sibanda [2014], and Yao, Ma, and He valid method for identifying HB (or not) because it is
[2014]. Starting down a new path, we use detrended not a fully random mix of stocks; it is not representative
uctuation analysis (DFA)the preferred method from of the indices designed to consist of a random mix of
econophysics to identify nonrandom movements in time stocks. While DFA is currently most popular among
series of various kindsto attempt to identify the transi- econophysicists, there are various other methods yet to
tion from EMB to HB and the bubble build-up in the be explicitly tested as indicators of the EMB-to-HB tran-
NASDAQ Composite Index from January 4, 1993 to July sition, for example, R/S analysis (Hurst [1951], Hurst,
26, 2002 (which also includes the crash starting on Black, and Sinaika [1965]), power spectral density
March 10, 2000). DFA reduces a time series into a series (Heneghan and McDarby [2000]), ARFIMA estimation
of time-series segments, which, if one follows what (Sowell [1992]), wavelets (Muzy et al. [1994], Gencay,
Peng et al. [1995] do, are then subdivided several times Selcuk, and Whitcher [2002]; Yalamova [2003]), log
174 M. J. M. TORRECILLAS ET AL.

periodicity (Johansen and Sornette [1999], Sornette and a poor method or rather that HB frequently strengthens
Johansen [2001]), generalized Hurst exponent (Di Mat- now and then but also goes back to a lying in wait state,
teo [2007]), and most recently a geometric method (Tri- such as herding versus random behaviors in buffalo
nidad, Fernandez, and Sanchez [2012]) or the cross- herds? Further results also lie in wait.
sectional standard versus absolute deviation (Chen What does H D 0.5 really mean? We see: (1) a very
[2013]). Most of the former have been used to identify low H D 0.02 segment (in row a) indicating anti-persis-
multifractality in stock markets and/or attempt predic- tence in volatility; frequent reversals; (2) an H D 0.97
tions of crash points rather than the starting points of segment (in row a) that includes both strong herd selling
bubble build-ups. At this point we favor weekly uctua- and buying behaviors, that is, high persistence in volatil-
tions because they produce more differentiated H values, ity; and (3) an H D 0.49 segment (in row h from weeks
but daily uctuations may offer improved accuracy in 326425) that includes dramatic before crash HB buy-
very short segments. ing and dramatic after crash HB selling, and the H D
There are several kinds of follow-on research to be 0.44 segment in the row j (weeks 301450). Yet econo-
pursued. First, we have used DFA, which essentially physicists dene H D 0.5 as indicating only white noise
looks for PL-distributed uctuations in the data to make or Brownian motion, that is, random buying and sell-
the H estimate. But PL methods may be used without ing. In stock market time series, H equals roughly 0.5
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using the H exponent. We believe PLs (i.e., H > 0.6) cannot be assumed to only indicate random Brownian
offer the best indication of the EMB-to-HB transition; motion. In Figure 5, we see obvious indications that per-
however, DFA and other methods (several listed just sistent within-segment HB-caused buying and then sell-
above), need to be empirically compared to see which ing (i.e., high Hs before and after the crash) can produce
one is the best indicator of HB. There is no research to H 0.5 when combined within one segment.
date that explicitly compares the various methods men- Our H and HB ndings reduce to four critical points:
tioned just above as to how well they identify the EMB- 1. For nance: DFA and the H exponent do show that
to-HB transition in a well-known bubble-build-up. Sec- emergent HB is demonstrably associated with the
ond, DFA offers on-off indications of HB (i.e., high Hs transition from EMB to HB. Only after segments
in some segments but not others) in what is recognized consistently showing H > 0.6 do we see a consis-
as a very obvious bubble build-up; DFA may turn out to tent and more dramatic rise in the NASDAQ
be useless in less pronounced bubble situations. But of index.
course, there are always sub-bubbles waiting to be identi- 2. For econophysics: DFA analysis and H > 0.6 indi-
ed in any stock market, as indicated by the various mul- cations are at the mercy of segment lengths and
tifractal price-change ndings.22 Third, the most obvious starting dates. There is also some likelihood that
means of further testing DFAs and other methods abil- multifractality within a segment could show H is
ity to indicate the start of HB is to focus on even less ran- roughly 0.5 rather than consistent persistence
domly composed indices than NASDAQ. HB would be because persistence could be created by periods of
more likely to occur in these indices. Finally, one could consistent buying and consistent selling within the
also move the foregoing research to an articial com- same segment. Strong HB in different directions
puter-based stock market where one could rst create (up or down) can easily produce an H is 0.5 when
HB-based stock buying and then test how well DFA or in fact random Brownian motion is nowhere in
other methods identify the EM-to-HB transition; Lamba sight.
and Seaman [2008] offer the rst study starting down 3. For both: A: Given (a) sequences in buying or sell-
this path. ing; (b) PLs as indicators of H; (c) that the presence
We have not found an obvious solution to the of H > 0.6 indicates HB; and (d) that our ndings
dilemma; that is, the shorter the segment (which is show HB producing up and down sequences
good for early indications by traders) the more unreliable within single segments, there is an empirical basis
the H indication. Buying and selling in stock markets, for using H > 0.6 to indicate HB and consequently
however, is more about when to take how-much risk persistence in rising or falling prices (and underly-
rather than statistically signicant scientic-truth nd- ing volatility). B: Though DFA appears to be a use-
ing. Traders presumably would not choose to wait until ful method for estimating H and hence identifying
scientic proof indicates that HB has seeped into a HB, segment lengths and their starting dates are
stock index. But H values become more and more ques- critical, however. Given the results shown in
tionable as the smallest subsegment length is shortened. Figure 3, what appears to be needed is a computer
In our row a, for example, the H values mostly alternate model that is able to constantly change and calcu-
high and low from one segment to the next. Is this about late Hs for the full range of segment lengths and
THE JOURNAL OF BEHAVIORAL FINANCE 175

starting dates pertaining to an ongoing nancial Potters [2000], Sornette [2003], Malevergne and Sornette
time series so as to identify persistent user behav- [2005], Jondeau et al. [2007], Calvet and Fisher [2008],
iors, that is, H  0.6 and evidence of herding. Gabaix [2009], Yuan, Zhuang, and Xiu [2009], Mandel-
brot [2010], Barunik et al. [2012], Kristoufek and Vosvrda
4. The DFA method is not able to indicate whether [2013], Schinckus [2013], Siokis [2013].
HB is persistently aimed at buying or selling. The 8. See also Newman [2005], Newman, Barabasi, and Watts
various segments in Figure 3 show that H > 0.6 [2006], Chou and Keane [2009], and Glaser [2012].
can indicate upward, or downward, or both up and McKelvey and Salmador [2011] list another 60 or so spe-
down price movements within a single segment. cically in nancial economics.
9. Self-organized criticality characterizes a system if it is able
Consequently, we have reason to question whether
to self-organize itself so as to maintain its viability in the
DFA and related methods that depend on the reli- context of constantly changing internal or external condi-
ability of H for being able to indicate persistent tions. PL distributions usually dene such systems.
rises or falls in stock prices based on PL indicated 10. Correlation between power law and straight line is 0.984.
behaviors are valid methods for anticipating crash Data are Dow Jones stock market prices in 1960. Firms
points. Therefore, based on our analysis of one of include AT&T Inc., General Motors Company, Interna-
tional Business Machines Corporation, Standard Oil, E. I.
the all-time dramatic and obvious bubble-build- du Pont de Nemours and Company, and General Electric
ups and crashesNASDAQ: 19932002there is Company.
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some reason to be skeptical about the use of DFA 11. See Goldfarb, Kirsch, and Miller [2007], Dyer et al. [2008],
and H to predict an impending crash. Tan et al. [2008], Yook and Kim [2008], Hott [2009], Bad-
deley [2010], Jeon and Moffett [2010], Blasco, Corredor,
and Ferreruela [2011], Alvarez et al. [2012], Prosad,
Notes Kapoor, and Sengupta [2012], Rejichi and Aloui [2012],
Saumitra and Sidharth [2012], Gao et al. [2013], Laih and
1. Others include Froot, Scharfstein, and Stein [1992], Tru- Liau [2013], Kristoufek and Vosvrda [2013], Ouarda, El
man [1994], Christie and Huang [1995], Grinblatt, Tit- Bouri, & Bernard [2013], Reboredo et al. [2013], Sensoy
man, and Wermers [1995], Devenow and Welch [1996], [2013].
Avery and Zemsky [1998], among others. 12. Multifractal means that the visual chart depictions of
2. For example, Chang, Cheng, and Khorana [2000], Cont many small, to fewer large, to a single very large
and Bouchaud [2000], Shiller [2000, 2002], Shleifer stock-market price movement looks more or less the
[2000], Welch [2000], Bikhchandani and Sharma [2001], same (i.e., self-similar) at multiple points as a time
Brunnermeier [2001], Hirshleifer and Teoh [2003], Parker series progresses because of on-&-off herd behaviors.
and Prechter [2005], Bernhardt, Campello, and Kutsoati Multiscaling refers to the likelihood that herding can
[2006], Clarke and Subramanian [2006], Hirshleifer, Sub- be stronger or weaker, thereby changing the steepness
rahmanyam, and Titman [2006], Rook [2006]. of a specic price change progression and/or how long
3. For example, Gopikrishnan et al. [1999], Muzy et al. it continues.
[2001], Mandelbrot and Hudson [2004], Gabaix et al. 13. See also Muzy et al. [2001], Lux and Ausloos [2002],
[2007], Lux [2004], Stanley, Plerou, and Gabaix [2008], Matia, Ashkenazy, and Stanley [2003], Borland et al.
Zunino et al. [2009], Mandelbrot [2010], Barunik et al. [2005], Calvet and Fisher [2008], Du and Ning [2008],
[2012], Yuan, Zhuang, and Liu [2012], Wang, Ziang, and Barunik et al. [2012], Yuan, Zhuang, and Liu [2012], Sio-
Pandey [2012], Pavon-Domnguez [2013], Siokis [2013], kis [2013], Wang and Xie [2013].
Sensoy [2013], Wang and Xie [2013], Suarez-Garcia and 14. Such as Michalski [2008], Sanchez, Trinidad, and Garca
Gomez-Ullate [2014]. [2008], Cajueiro, Tabak, and Werneck [2009], Yan,
4. See Barabasi [2002], Battiston and Catanzaro [2004], Gay Woodard, and Sornette [2010], Barunik and Kristoufek
and Dousset [2005], Souma et al. [2006], Chmiel et al. [2011], Sanchez, Fernandez, and Trinidad [2012], to name
[2007], Santiago and Benito [2008], Gerow and Keane a few.
[2011], Hu et al. [2013], Mizuno, Souma, and Watanabe 15. Observers could say that the bubble began with the begin-
[2014]. ning of NASDAQ. We pick January 4, 2015, starting date
5. For example, Gopikrishnan et al. [1999], Lo and MacKin- because the index stayed relatively at for the year of
lay [1999], Sornette [2003], Jondeau, Poon, and Rockinger 1992, gaining only 84 points.
[2007], Stanley, Plerou, and Gabaix [2008], Jiang et al. 16. See also Hu et al. [2001], Chen et al. [2002], Matia, Ashke-
[2010], Alvarez-Ramirez et al. [2012], Reboredo et al. nazy, and Stanley [2003], Grech and Mazur [2004], Matos
[2013]. et al. [2007], Alvarez-Ramirez et al. [2008], Serletis, Urit-
6. The Economist especially emphasizes its and others con- skaya, and Uritsky [2008], Wang, Wei, and Wu [2011],
cerns about value at risk, correlated trading behaviors and Yuan, Zhuang, and Liu [2012], Chen [2013], Pav on et al.
price movements, as well as positive feedback in its 18 [2013], Kristoufek and Vosvrda [2013], Reboredo et al.
page Special Report on Financial Risk (February 13, 2010, [2013], Sensoy [2013], Suarez-Garcia and Gomez-Ullate
inserted between pp. 52 and 53). [2014], among others.
7. More recently, the works of Schroeder [1991], Peters 17. For Peng et al.: Rank goes from the smallest to the one
[1994], West and Deering [1995], Lo and MacKinlay largest segment out at the end of the X-axis. Frequency
[1999], Mantegna and Stanley [2000], Bouchaud and goes from the average uctuation within the smallest
176 M. J. M. TORRECILLAS ET AL.

segments nearest to the origin up to the average uctua- Ausloos, M., N. Vandewalle, P. Boveroux, A. Minguet, and K.
tions within the single largest segment up at the end of the Ivanova. Applications of Statistical Physics to Economic
Y-axis. and Financial Topics. Physica A, 274, (1999), pp. 229240.
18. The program we used to calculate DFAs and the H expo- Avery, C. and P. Zemsky. Multidimensional Uncertainty and
nents and create the PL graphs was coded up in MATLAB Herd Behavior in Financial Markets. The American Eco-
by Max Little et al. [2006]. nomic Review, 88, (1998), pp. 724748.
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