Collective behavior of stock prices as a precursor to market crash

TL;DR

This paper investigates how collective behavior in stock returns, especially the rise in market-wide modes and news sentiment, served as a precursor to the 2008 global market crash, highlighting the role of collective dynamics.

Contribution

It introduces an analysis of market mode behavior as a precursor to crashes, linking collective stock behavior and news sentiment to market instability.

Findings

Sharp increase in collective behavior before the crash

News about 'financial crisis' correlated with increased market mode variance

Variance grew following a power law with cumulative news amount

Abstract

We study precursors to the global market crash that occurred on all main stock exchanges throughout the world in October 2008 about three weeks after the bankruptcy of Lehman Brothers Holdings Inc. on 15 September. We examine the collective behavior of stock returns and analyze the market mode, which is a market-wide collective mode, with constituent issues of the FTSE 100 index listed on the London Stock Exchange. Before the market crash, a sharp rise in a measure of the collective behavior was observed. It was shown to be associated with news including the words "financial crisis." They did not impact stock prices severely alone, but they exacerbated the pessimistic mood that prevailed among stock market participants. Such news increased after the Lehman shock preceding the market crash. The variance increased along with the cumulative amount of news according to a power law.