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Week 39/2008: Understanding wildly behaving stocks

Tommi Vuorenmaa's doctoral dissertation in econometrics concerning the volatility of stock prices became topical just a few days before its public defence as stock prices fluctuated wildly around the world.

“Very few people were able to anticipate something like that,” says Vuorenmaa.
He explains that the fluctuations in stock prices have long since proven to be much more susceptible to risk than shown by traditional models.

”During the last ten years, we have witnessed a number of crises so serious that, according to the standard model, they should only take place once in a hundred years. The actual events are more dramatic and extreme than the models indicate.”

In his dissertation in econometrics, Vuorenmaa seeks to explain the fluctuations in stock prices by collecting stock exchange data at shorter intervals than in traditional studies. He analyses the developments in stock prices by taking into account all trades, not just the daily prices.

“In this way, higher probabilities are obtained for events commonly thought to be rare. The frequency of data collection affects the perception of risks.”

Estimates on the volatility of stock prices affect, for instance, investment recommendations, hedging strategies, and option arrangements. The dissertation argues for the need to reform options pricing and risk management.

Vuorenmaa also studies the effects of trading rules on fluctuations in stock prices. He estimates that international trading rules will be subject to extensive consideration from the point of view of restricting the volatility of stock prices.

The interdisciplinary dissertation uses the methods of telecommunication, acoustics, and statistical physics, among others. A part of the study belongs to the area of econophysics.

“It is a new field of science developed by physicists in which the research methods of physics are applied to the study of economics.”

Vuorenmaa's doctoral dissertation in economics, Elements of Volatility at High Frequency, was publicly examined at the Faculty of Social Sciences on 19 September.

Text: Kyösti Niemelä
Picture: Wikipedia
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Translation: AAC Noodi