Discussion on a Risk Measurement Indicator for Crash Phenomena in Markets

Abstract

The purpose of this research is to contribute to analyze market crash mechanism from the idea of a new measurement for crash risk in financial markets. Observed market crisis occurred past 20 years, the more technological development has been advanced, the more serious financial market collapsed such as the failure of Long-Term Capital Management (LTCM) taken place in summer of 1998 and Lehman collapsed in 2008. In the financial world, it has been assumed that the distributions of asset returns are all normal, however I could find it market crash should be linkage to decay or violate normality assumption. When crisis occurs, distribution becomes non-normal. Moreover recent financial technology controls return distribution that shows their investment management skills in hedge fund industry as well. The point is that if we capture timing of transition between normal state and non normal state in markets, it could be a sort of signal. For this research, correlation playing important role and calculating eigen value from correlation matrix. I observed shape of eigen value curve and used hypothetical correlation as a risk measurement parameter. Threshold shows correlation states in the market and provides an indicator.