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Unformatted text preview: Electronic copy available at: http://ssrn.com/abstract=1596039 Bubble Diagnosis and Prediction of the 2005-2007 and 2008-2009 Chinese stock market bubbles Zhi-Qiang Jiang, Wei-Xing Zhou, D. Sornette, Ryan Woodard, Ken Bastiaensen, Peter Cauwels CCSS Working Paper Series CCSS-09-008 CCSS , the Competence Center Coping with Crises in Complex Socio-Economic Systems , was established at ETH Zurich (Switzerland) in September 2008. By means of theoretical and empirical analysis, CCSS aims at understanding the causes of and cures to crises in selected problem ar- eas, for example in financial markets, in societal infrastructure, or crises involving political violence. More information can be found at: http://www.ccss.ethz.ch/ . Electronic copy available at: http://ssrn.com/abstract=1596039 CCSS-09-008 Bubble Diagnosis and Prediction of the 2005-2007 and 2008-2009 Chinese stock market bubbles Zhi-Qiang Jiang, Wei-Xing Zhou, D. Sornette, Ryan Woodard, Ken Bastiaensen, Peter Cauwels Abstract By combining (i) the economic theory of rational expectation bubbles, (ii) behavioral finance on imitation and herding of investors and traders and (iii) the mathematical and statistical physics of bifurcations and phase transitions, the log-periodic power law (LPPL) model has been developed as a flexible tool to detect bubbles. The LPPL model considers the faster-than-exponential (power law with finite-time singularity) increase in asset prices decorated by accelerating oscillations as the main diagnostic of bubbles. It embodies a positive feedback loop of higher return anticipations competing with negative feedback spirals of crash expectations. We use the LPPL model in one of its incarnations to analyze two bubbles and subsequent market crashes in two important indexes in the Chinese stock markets between May 2005 and July 2009. Both the Shanghai Stock Exchange Composite index (US ticker symbol SSEC) and Shenzhen Stock Exchange Component index (SZSC) exhibited such behavior in two distinct time periods: 1) from mid-2005, bursting in October 2007 and 2) from November 2008, bursting in the beginning of August 2009. We successfully predicted time windows for both crashes in advance (Sornette, 2007; Bastiaensen et al., 2009) with the same methods used to successfully predict the peak in mid-2006 of the US housing bubble (Zhou and Sornette, 2006b) and the peak in July 2008 of the global oil bubble (Sornette et al., 2009). The more recent bubble in the Chinese indexes was detected and its end or change of regime was predicted independently by two groups with similar results, showing that the model has been well-documented and can be replicated by industrial practitioners. Here we present more detailed analysis of the individual Chinese index predictions and of the methods used to make and test them. We complement the detection of log-periodic behavior with Lomb spectral analysis of detrended residuals and ( H,q )-derivative of logarithmic indexes for both bubbles. We perform unit-root-derivative of logarithmic indexes for both bubbles....
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