Chaos and Nonlinear Dynamics: Application to Financial Markets

TLDR

After the 1987 crash, the frequency of large stock market moves exceeding normal expectations spurred interest in nonlinear and chaotic dynamics as a possible explanation for market behavior. This paper investigates whether chaotic dynamics underlie financial markets by examining detection methods and alternative explanations.

Abstract

ABSTRACT After the stock market crash of October 19, 1987, interest in nonlinear dynamics, especially deterministic chaotic dynamics, has increased in both the financial press and the academic literature. This has come about because the frequency of large moves in stock markets is greater than would be expected under a normal distribution. There are a number of possible explanations. A popular one is that the stock market is governed by chaotic dynamics. What exactly is chaos and how is it related to nonlinear dynamics? How does one detect chaos? Is there chaos in financial markets? Are there other explanations of the movements of financial prices other than chaos? The purpose of this paper is to explore these issues.