Scandinavian Working Papers in Economics

Working Paper Series,
Uppsala University, Department of Economics

No 2010:25: Measuring the Stability of a Dynamic System: The Case of the Stock Market Turmoil 2007-2008

Mikael Bask () and Anna Widerberg ()
Additional contact information
Mikael Bask: Department of Economics, Postal: Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden
Anna Widerberg: Department of Economics Göteborg University, Postal: SE-405 30 Göteborg, Sweden

Abstract: The aim of this paper is to demonstrate how the change in actual and potential market risks in the Dow Jones Industrial Average (DJIA) during the two-year period 2007-2008 can be analyzed with the help of (lambda,sigma-2)-analysis. In the empirical analysis, the average of the Lyapunov exponents for the dynamic system generating DJIA returns is used as the stability measure, lambda, whereas the squared DJIA return is used as the variability measure, sigma-2. The main findings are as follows: (i) the potential market risk in the DJIA did not fluctuate that much during 2007, with the exceptions of early fall and near the end of the year; (ii) the potential market risk fluctuated a lot during 2008, especially in early August and in the middle of September; and (iii) the actual market risk in the DJIA was considerably higher near the end of 2008, especially in October, compared with the rest of the period.

Keywords: Dow Jones; Financial Crisis; Lyapunov Exponents; Market Risk; Potential Market Risk; Stability; Volatility

JEL-codes: G01

20 pages, December 28, 2010

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