Explaining What Leads Up to Stock Market Crashes: A Phase Transition Model and Scalability Dynamic

The market crash as phase transition in Johansen and Sornette (1999) points at the analogy between the three states of a physical system (solid, liquid and gas) and stock market dynamics at a "microscopic" level, where the individual trader has only three possible actions: selling, buying or waiting. According to this model at the critical point order prevails in the market as all traders have the same opinion sell which leads to “significant drawdowns”. We do not offer an alternative to EMH/CAPM but extend the existing framework to accommodate situations with higher information complexity, interactions with positive  feedback, and extreme events that cannot be simply explained by presuming independent-additive data point, and normal distributions. This is a joint work with Bill McKelvey (UCLA Anderson School of Management)