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Abstract
We use insight from a model of earth techtonic plate movement to obtain a new understanding of the build up and release of stress in the price dynamics of the world’s stock exchanges. Nonlinearity enters the model due to a behavioral attribute of humans reacting disproportionately to big changes. This nonlinear response allows us to classify price movements of a given stock index as either being generated due to specific economic news for the country in question, or by the ensemble of the world’s stock exchanges reacting together like a complex system. Similar in structure to the Capital Asset Pricing Model in Finance, the model predicts how an individual stock exchange should be priced in terms of the performance of the global market of exchanges, but with human behavioral characteristics included in the pricing. A number of the model’s assumptions are validated against empirical data for 24 of the world’s leading stock exchanges. We show how threshold effects can lead to synchronization in the global network of stock exchanges.
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