Information dissipation as an early-warning signal for the Lehman Brothers collapse in financial time series

Inferring Dealer Networks in the Foreign Exchange Market Using Conditional Transfer Entropy: Analysis of a Central Bank Announcement

The foreign exchange (FX) market has evolved into a complex system where locally generated information percolates through the dealer network via high-frequency interactions. Information related to major events, such as economic announcements, spreads rapidly through this network, potentially inducing volatility, liquidity disruptions, and contagion effects across financial markets. Yet, research on the mechanics of information flows in the FX market is limited. In this paper, we introduce a novel approach employing conditional transfer entropy to construct networks of information flows. Leveraging a unique, high-resolution dataset of bid and ask prices, we investigate the impact of an announcement by the European Central Bank on the information transfer within the market. During the announcement, we identify key dealers as information sources, conduits, and sinks, and, through comparison to a baseline, uncover shifts in the network topology.

Measure cross-sectoral structural similarities from financial networks

Auditing is a multi-billion dollar market, with auditors assessing the trustworthiness of financial data, contributing to financial stability in a more interconnected and faster-changing world. We measure cross-sectoral structural similarities between firms using microscopic real-world transaction data. We derive network representations of companies from their transaction datasets, and we compute an embedding vector for each network. Our approach is based on the analysis of 300+ real transaction datasets that provide auditors with relevant insights. We detect significant changes in bookkeeping structure and the similarity between clients. For various tasks, we obtain good classification accuracy. Moreover, closely related companies are near in the embedding space while different industries are further apart suggesting that the measure captures relevant aspects. Besides the direct applications in computational audit, we expect this approach to be of use at multiple scales, from firms to countries, potentially elucidating structural risks at a broader scale.

Early warnings for multi-stage transitions in dynamics on networks

Successfully anticipating sudden major changes in complex systems is a practical concern. Such complex systems often form a heterogeneous network, which may show multi-stage transitions in which some nodes experience a regime shift earlier than others as an environment gradually changes. Here we investigate early warning signals for networked systems undergoing a multi-stage transition. We found that knowledge of both the ongoing multi-stage transition and network structure enables us to calculate effective early warning signals for multi-stage transitions. Furthermore, we found that small subsets of nodes could anticipate transitions as well as or even better than using all the nodes. Even if we fix the network and dynamical system, no single best subset of nodes provides good early warning signals, and a good choice of sentinel nodes depends on the tipping direction and the current stage of the dynamics within a multi-stage transition, which we systematically characterize.

Evaluating the performance of multivariate indicators of resilience loss

Various complex systems, such as the climate, ecosystems, and physical and mental health can show large shifts in response to small changes in their environment. These 'tipping points' are notoriously hard to predict based on trends. However, in the past 20 years several indicators pointing to a loss of resilience have been developed. These indicators use fluctuations in time series to detect critical slowing down preceding a tipping point. Most of the existing indicators are based on models of one-dimensional systems. However, complex systems generally consist of multiple interacting entities. Moreover, because of technological developments and wearables, multivariate time series are becoming increasingly available in different fields of science. In order to apply the framework of resilience indicators to multivariate time series, various extensions have been proposed. Not all multivariate indicators have been tested for the same types of systems and therefore a systematic comparison between the methods is lacking. Here, we evaluate the performance of the different multivariate indicators of resilience loss in different scenarios. We show that there is not one method outperforming the others. Instead, which method is best to use depends on the type of scenario the system is subject to. We propose a set of guidelines to help future users choose which multivariate indicator of resilience is best to use for their particular system.

Using critical slowing down indicators to understand economic growth rate variability and secular stagnation

This paper utilizes Critical Slowing Down (CSD; instability) indicators developed by statistical physics to analyse economic growth rate variability and secular stagnation in historical GDP data. Understanding these phenomena is vital, particularly in advanced economies faced with declining growth rates. Two novel indicators - the autocorrelation (AR1) and the variance – are found particularly useful in providing insight into inter-decadal GDP variability over this period. These indicators are first applied to the Maddison-Project historical dataset, which includes almost a century of data for some 80 countries and almost two centuries of data for 9 countries. They are additionally applied to ~50 years of recent annual data for around 130 countries from the World Bank dataset as well as ~60 years of recent quarterly data for around 20 countries from the OECD dataset. Analysis reveals inter-decadal variability in growth cycles (the recession cycle), highlighting periods of large slow growth cycles and periods of small fast growth cycles. The most commonly occurring pattern is characterised by an increase in CSD from the 1900s to 1940s, a decline in CSD between the 1930s and the 1970s, then a further increase in CSD from the 1960s to 2010. This pattern is significant in ~70% of the advanced economies. CSD indicators may then provide invaluable insights into specific aspects of inter-decadal GDP variability, such as on the nature of the business cycle, secular stagnation and the implicit “restoring forces” of the economy.

Detecting Critical Transitions in the Human Innate Immune System Post-cardiac Surgery

Coronary artery bypass grafting with cardiopulmonary bypass activates the human innate immune system (HIIS) and invokes a vigorous inflammatory response that is systemic. This massive inflammatory reaction can contribute to the development of postoperative complications that could topple the state of the system from health to disease, or even to some extent, death. The body, after all, is in a state where majority of its immune cell populations have been depleted, and sometimes needs days or even longer to recuperate. To obtain a deeper understanding on how HIIS responds to complications after cardiac surgery, we perturb the immune system model that we have developed in an earlier work in-silico by adding another source of inflammation triggering moieties (ITMs) hours after surgery in various regimes. A critical transition occurs upon the addition of a critical concentration of ITMs when the insult is sustained for approximately 3 h – a total concentration that corresponds to the fatal concentration of ITMs documented in literature. By perturbing HIIS in-silico with additional sources of ITMs to mimic persistent and recurring episodes of post-surgery complications, we are able to specify under which conditions critical transitions occur in HIIS, as well as pinpoint important blood parameters that exhibit critical transitions in our model. More importantly, by applying early warning signals on the clinical trial data used to calibrate and validate HIIS model, we are able to detect blood parameters that exhibit critical transitions in patients who died post-surgery, where pro-inflammatory cytokines are deemed potential markers for critical transitions.

A study on the dynamics of temporary HIV treatment to assess the controversial outcomes of clinical trials: An in-silico approach

It is still unclear under which conditions temporary combined antiretroviral therapy (cART) results in a prolonged remission after interruption. Clinical trials have contradicting reposts about the effect of cART during primary HIV infection on the disease progression. Here we propose that the apparent contradiction is due the presence of a window of opportunity for cART treatment observed in the in silico studies. We study non-linear correlations in the HIV dynamics over time using information theory. This approach requires a large dataset of CD4+ T lymphocytes and viral load concentrations over time. Since it is unfeasible to collect the required amount of data in clinical trials we use C-ImmSim, a clinically validated in silico model of the HIV infection, to simulate the HIV infection and temporary cART in 500 virtual patients for a period of 6 years post infection in time steps of 8 hours. We validate the results of our model with two published clinical trials of temporary cART in acute infection and analyse the impact of cART on the immune response. Our quantitative analysis predicts a “window of opportunity” of about ten months after the acute phase during which a temporary cART has significantly longer-lasting beneficial effects on the immune system as compared to treatment during the chronic phase. This window may help to explain the controversial outcomes of clinical trials that differ by the starting time and duration of the short-term course cART and provides a critical insight to develop appropriate protocols for future clinical trials.

The Gaussian Graphical Model in Cross-Sectional and Time-Series Data

We discuss the Gaussian graphical model (GGM; an undirected network of partial correlation coefficients) and detail its utility as an exploratory data analysis tool. The GGM shows which variables predict one-another, allows for sparse modeling of covariance structures, and may highlight potential causal relationships between observed variables. We describe the utility in three kinds of psychological data sets: data sets in which consecutive cases are assumed independent (e.g., cross-sectional data), temporally ordered data sets (e.g., n = 1 time series), and a mixture of the 2 (e.g., n > 1 time series). In time-series analysis, the GGM can be used to model the residual structure of a vector-autoregression analysis (VAR), also termed graphical VAR. Two network models can then be obtained: a temporal network and a contemporaneous network. When analyzing data from multiple subjects, a GGM can also be formed on the covariance structure of stationary means-the between-subjects network. We discuss the interpretation of these models and propose estimation methods to obtain these networks, which we implement in the R packages graphicalVAR and mlVAR. The methods are showcased in two empirical examples, and simulation studies on these methods are included in the supplementary materials.

Systemic risk and hierarchical transitions of financial networks

In this paper, the change in topological hierarchy, which is measured by the minimum spanning tree constructed from the cross-correlations between the stock indices from the S & P 500 for 1998-2012 in a one year moving time window, was used to analyze a financial crisis. The hierarchy increased in all minor crises in the observation time window except for the sharp crisis of 2007-2008 when the global financial crisis occurred. The sudden increase in hierarchy just before the global financial crisis can be used for the early detection of an upcoming crisis. Clearly, the higher the hierarchy, the higher the threats to financial stability. The scaling relations were developed to observe the changes in hierarchy with the network topology. These scaling relations can also identify and quantify the financial crisis periods, and appear to contain the predictive power of an upcoming crisis.

The Asian Correction Can Be Quantitatively Forecasted Using a Statistical Model of Fusion-Fission Processes

The Global Financial Crisis of 2007-2008 wiped out US$37 trillions across global financial markets, this value is equivalent to the combined GDPs of the United States and the European Union in 2014. The defining moment of this crisis was the failure of Lehman Brothers, which precipitated the October 2008 crash and the Asian Correction (March 2009). Had the Federal Reserve seen these crashes coming, they might have bailed out Lehman Brothers, and prevented the crashes altogether. In this paper, we show that some of these market crashes (like the Asian Correction) can be predicted, if we assume that a large number of adaptive traders employing competing trading strategies. As the number of adherents for some strategies grow, others decline in the constantly changing strategy space. When a strategy group grows into a giant component, trader actions become increasingly correlated and this is reflected in the stock price. The fragmentation of this giant component will leads to a market crash. In this paper, we also derived the mean-field market crash forecast equation based on a model of fusions and fissions in the trading strategy space. By fitting the continuous returns of 20 stocks traded in Singapore Exchange to the market crash forecast equation, we obtain crash predictions ranging from end October 2008 to mid-February 2009, with early warning four to six months prior to the crashes.

Lack of Critical Slowing Down Suggests that Financial Meltdowns Are Not Critical Transitions, yet Rising Variability Could Signal Systemic Risk

Complex systems inspired analysis suggests a hypothesis that financial meltdowns are abrupt critical transitions that occur when the system reaches a tipping point. Theoretical and empirical studies on climatic and ecological dynamical systems have shown that approach to tipping points is preceded by a generic phenomenon called critical slowing down, i.e. an increasingly slow response of the system to perturbations. Therefore, it has been suggested that critical slowing down may be used as an early warning signal of imminent critical transitions. Whether financial markets exhibit critical slowing down prior to meltdowns remains unclear. Here, our analysis reveals that three major US (Dow Jones Index, S&P 500 and NASDAQ) and two European markets (DAX and FTSE) did not exhibit critical slowing down prior to major financial crashes over the last century. However, all markets showed strong trends of rising variability, quantified by time series variance and spectral function at low frequencies, prior to crashes. These results suggest that financial crashes are not critical transitions that occur in the vicinity of a tipping point. Using a simple model, we argue that financial crashes are likely to be stochastic transitions which can occur even when the system is far away from the tipping point. Specifically, we show that a gradually increasing strength of stochastic perturbations may have caused to abrupt transitions in the financial markets. Broadly, our results highlight the importance of stochastically driven abrupt transitions in real world scenarios. Our study offers rising variability as a precursor of financial meltdowns albeit with a limitation that they may signal false alarms.

Identifying early-warning signals of critical transitions with strong noise by dynamical network markers

Identifying early-warning signals of a critical transition for a complex system is difficult, especially when the target system is constantly perturbed by big noise, which makes the traditional methods fail due to the strong fluctuations of the observed data. In this work, we show that the critical transition is not traditional state-transition but probability distribution-transition when the noise is not sufficiently small, which, however, is a ubiquitous case in real systems. We present a model-free computational method to detect the warning signals before such transitions. The key idea behind is a strategy: “making big noise smaller” by a distribution-embedding scheme, which transforms the data from the observed state-variables with big noise to their distribution-variables with small noise, and thus makes the traditional criteria effective because of the significantly reduced fluctuations. Specifically, increasing the dimension of the observed data by moment expansion that changes the system from state-dynamics to probability distribution-dynamics, we derive new data in a higher-dimensional space but with much smaller noise. Then, we develop a criterion based on the dynamical network marker (DNM) to signal the impending critical transition using the transformed higher-dimensional data. We also demonstrate the effectiveness of our method in biological, ecological and financial systems.

Predicting the Lifetime of Dynamic Networks Experiencing Persistent Random Attacks

Estimating the critical points at which complex systems abruptly flip from one state to another is one of the remaining challenges in network science. Due to lack of knowledge about the underlying stochastic processes controlling critical transitions, it is widely considered difficult to determine the location of critical points for real-world networks, and it is even more difficult to predict the time at which these potentially catastrophic failures occur. We analyse a class of decaying dynamic networks experiencing persistent failures in which the magnitude of the overall failure is quantified by the probability that a potentially permanent internal failure will occur. When the fraction of active neighbours is reduced to a critical threshold, cascading failures can trigger a total network failure. For this class of network we find that the time to network failure, which is equivalent to network lifetime, is inversely dependent upon the magnitude of the failure and logarithmically dependent on the threshold. We analyse how permanent failures affect network robustness using network lifetime as a measure. These findings provide new methodological insight into system dynamics and, in particular, of the dynamic processes of networks. We illustrate the network model by selected examples from biology, and social science.

Collective attention and stock prices: evidence from Google Trends data on Standard and Poor's 100

Today´s connected world allows people to gather information in shorter intervals than ever before, widely monitored by massive online data sources. As a dramatic economic event, recent financial crisis increased public interest for large companies considerably. In this paper, we exploit this change in information gathering behavior by utilizing Google query volumes as a "bad news" indicator for each corporation listed in the Standard and Poor´s 100 index. Our results provide not only an investment strategy that gains particularly in times of financial turmoil and extensive losses by other market participants, but reveal new sectoral patterns between mass online behavior and (bearish) stock market movements. Based on collective attention shifts in search queries for individual companies, hence, these findings can help to identify early warning signs of financial systemic risk. However, our disaggregated data also illustrate the need for further efforts to understand the influence of collective attention shifts on financial behavior in times of regular market activities with less tremendous changes in search volumes.

Cohesiveness in financial news and its relation to market volatility

Motivated by recent financial crises, significant research efforts have been put into studying contagion effects and herding behaviour in financial markets. Much less has been said regarding the influence of financial news on financial markets. We propose a novel measure of collective behaviour based on financial news on the Web, the News Cohesiveness Index (NCI), and we demonstrate that the index can be used as a financial market volatility indicator. We evaluate the NCI using financial documents from large Web news sources on a daily basis from October 2011 to July 2013 and analyse the interplay between financial markets and finance-related news. We hypothesise that strong cohesion in financial news reflects movements in the financial markets. Our results indicate that cohesiveness in financial news is highly correlated with and driven by volatility in financial markets.

The diminishing role of hubs in dynamical processes on complex networks

It is notoriously difficult to predict the behaviour of a complex self-organizing system, where the interactions among dynamical units form a heterogeneous topology. Even if the dynamics of each microscopic unit is known, a real understanding of their contributions to the macroscopic system behaviour is still lacking. Here, we develop information-theoretical methods to distinguish the contribution of each individual unit to the collective out-of-equilibrium dynamics. We show that for a system of units connected by a network of interaction potentials with an arbitrary degree distribution, highly connected units have less impact on the system dynamics when compared with intermediately connected units. In an equilibrium setting, the hubs are often found to dictate the long-term behaviour. However, we find both analytically and experimentally that the instantaneous states of these units have a short-lasting effect on the state trajectory of the entire system. We present qualitative evidence of this phenomenon from empirical findings about a social network of product recommendations, a protein–protein interaction network and a neural network, suggesting that it might indeed be a widespread property in nature.