Collective behavior of stock prices in the time of crisis as a response to the external stimulus

TL;DR

This paper investigates how external crises like the 2008 financial crisis and COVID-19 impact stock market behavior, revealing that increased correlations are driven by external stimuli rather than direct causality.

Contribution

It introduces a model incorporating external factors into stock price dynamics and demonstrates their influence during major crises.

Findings

Increased pair-wise Granger causality during crises due to external stimuli

Recurrence analysis supports external factors as common drivers

Modeling external effects explains market responses to crises

Abstract

We analyze the interaction between stock prices of big companies in the USA and Germany using Granger Causality. We claim that the increase in pair-wise Granger causality interaction between prices in the times of crisis is the consequence of simultaneous response of the markets to the outside events or external stimulus that is considered as a common driver to all the stocks, not a result of real causal predictability between the prices themselves. An alternative approach through recurrence analysis in single stock price series supports this claim. The observed patterns in the price of stocks are modelled by adding a multiplicative exogenous term as the representative for external factors to the geometric Brownian motion model for stock prices. Altogether, we can detect and model the effects of the Great Recession as a consequence of the mortgage crisis in 2007/2008 as well as the impacts of the Covid out-break in early 2020