Time Varying Moments, Regime Switch, and Crisis Warning: The Birth-Death Process with Changing Transition Probability

Yinan Tanga, ∗ and Ping Chena
aCenter for New Political Economy, Economic School, Fudan University, Shanghai
200433, China.
Physica A, Vol.414, pp.56-64 (2014)
http://dx.doi.org/10.1016/j.physa.2014.02.038
Submitted on Apr. 15, 2013
Revised Nov. 25, 2013
Accepted on Feb. 17, 2014

Abstract
The sub-prime crisis in the U.S. reveals the limitation of diversification strategy based on mean-variance analysis. A regime switch and a turning point can be observed using a high moment representation and time-dependent transition probability. Up-down price movements are induced by interactions among agents, which can be described by the birth-death (BD) process. Financial instability is visible by dramatically increasing 3rd to 5th moments one-quarter before and during the crisis.The sudden rising high moments provide effective warning signals of a regime-switch or a coming crisis. The critical condition of a market breakdown can be identified from nonlinear stochastic dynamics. The master equation approach of population dynamics provides a unified

Key Words: high moments, birth-death process, transition probability,regime switch, crisis warning
120140505083.pdf