Physics and the stock market: playing with fire
Jan 17, 2001
Financiers have long used statistics to forecast fluctuations on the stock market, and in recent years they have also employed models from high-energy physics and statistical physics. Now two French physicists have used theories of combustion to predict the future values of certain shares with surprising accuracy (C Tannous and A Fessant European Physical Journal submitted).
Combustion often appears to occur spontaneously after a long period of stability. Charbel Tannous and Alain Fessant of the Université de Bretagne Occidentale in Brest recognised that this is similar to the behaviour of some stocks that tend to jump in value suddenly after long spells of stability - a quality known as 'burstiness'. The pair decided to apply their knowledge of condensed matter physics to the fluctuations of the stock market. Their findings could help market analysts to predict when stock values will rise and fall, and by how much.
Simple models of combustion are based on changes in the concentration of fuel over time. Ignition takes place when the fuel concentration reaches a certain level. Tannous and Fessant modified the equations, replacing fuel concentration by the share prices of real companies. The researchers chose large and small companies from different industrial and economic backgrounds, and charted the variation in their share prices over five years.
For all six companies, the researchers found that the predictions of the combustion-inspired model very accurately matched the actual variation in the share price. "We would be delighted if financial analysts would consider deterministic approaches for predicting financial trends", Tannous told PhysicsWeb. "Combustion theory offers a natural framework for the description of bursty financial time series."
According to Tannous, this is the first time that combustion models have been used to predict the performance of companies. Tannous and Fessant do point out, however, that after the share value has jumped, market conditions become more important and the analogy with combustion models disappears.