Macroeconomic Phase Transitions Detected from the Dow Jones Industrial Average Time Series

TL;DR

This study analyzes the Dow Jones Industrial Average from 1997 to 2008, identifying macroeconomic phases through statistical segmentation, revealing patterns of volatility associated with economic cycles and specific financial crises.

Contribution

It introduces a method to detect macroeconomic phases from stock index data using segmentation and clustering, linking phases to volatility and economic events.

Findings

Most time spent in low- and high-volatility phases

Market crashes occur mainly during high-volatility phases

Transitions are preceded by identifiable shocks

Abstract

In this paper, we perform statistical segmentation and clustering analysis of the Dow Jones Industrial Average time series between January 1997 and August 2008. Modeling the index movements and log-index movements as stationary Gaussian processes, we find a total of 116 and 119 statistically stationary segments respectively. These can then be grouped into between five to seven clusters, each representing a different macroeconomic phase. The macroeconomic phases are distinguished primarily by their volatilities. We find the US economy, as measured by the DJI, spends most of its time in a low-volatility phase and a high-volatility phase. The former can be roughly associated with economic expansion, while the latter contains the economic contraction phase in the standard economic cycle. Both phases are interrupted by a moderate-volatility market, but extremely-high-volatility market crashes are found mostly within the high-volatility phase. From the temporal distribution of various phases, we see a high-volatility phase from mid-1998 to mid-2003, and another starting mid-2007 (the current global financial crisis). Transitions from the low-volatility phase to the high-volatility phase are preceded by a series of precursor shocks, whereas the transition from the high-volatility phase to the low-volatility phase is preceded by a series of inverted shocks. The time scale for both types of transitions is about a year. We also identify the July 1997 Asian Financial Crisis to be the trigger for the mid-1998 transition, and an unnamed May 2006 market event related to corrections in the Chinese markets to be the trigger for the mid-2007 transition.