The future, we all know, is in the stars. So it is appropriate that the multinational team of eggheads trying to predict bubbles in financial markets at Switzerland’s prestigious Federal Institute of Technology in Zurich should call itself the financial crisis “observatory”.
On Monday, the number gazers revealed the results of their boldest experiment to date – a six-month exercise, inaugurated last November and concluded this month, to see whether their mind-boggling mathematical models had real predictive power regarding four widely different asset classes.
From Brazil’s Bovespa equity index, a Merrill Lynch European corporate bond index, the gold spot price and, as of December, cotton futures, the mathematicians and economists put their algorithms to work identifying trends, based on a fundamental belief in their ability to detect underlying patterns. The aim was to test two key hypotheses: whether bubbles can be diagnosed in real time before they end; and whether the termination point can be predicted with a higher probability than just chance.
The result, according to Didier Sornette, professor of entrepreneurial risks, was broadly positive. The modelling was judged – using layman’s language – to have scored a win for the equity index and the gold price, a draw in the case of cotton, and be subject to a replay for the bond index, because of special circumstances.
Of course, mathematical modelling of complex financial markets is nothing new, even if the technological firepower being devoted to it is constantly evolving with spiralling computing power. Likewise, the models themselves are being steadily refined.
Needless to say, a precise judgment about the success of the experiment depends profoundly on the definitions and on where the experimenters place their goalposts. Some might quibble about the precise meaning of “bubble”, others about the degree of statistical correlation sufficient to deem a prediction accurate.
But “observatory” members argue that, in spite of any such definitional differences, and the fact that many others are also busily forecasting, their findings break new ground. While myriad academics are researching into market phenomena, Prof Sornette says most content themselves with proof of concept and looking to the past, rather than daring to make predictive forecasts, then publicly put to the test.
Perhaps more relevant to mere mortals, much of the brainpower being applied to such subjects is taking place behind the very closed doors of hedge funds and the like. By contrast, the Zurich team is based at a university where the incentive and mission is to publish. Emboldened by its first findings, the Zurich star gazers are now broadening their work to seven more asset classes, before boldly going even further. Some may dismiss their efforts as more akin to astrology than astrolonomy, but hedge funds are apparently already keen to learn more about their methods.
While the booming Chinese housing market is to form part of the observatory’s future constellation, Greek securities, whether private or public, most certainly will not, given their distinctly unbubble-like recent trajectory.
Last weekend’s massive aid package should, in theory, have eased financial market jitters and helped secure a rally after weeks of growing tension. Instead, European equities fell initially on Monday, before investors regained confidence – although only because of US data, rather than anything to do with Greece.
But in Germany, where Angela Merkel, chancellor, is facing a tricky regional election this weekend, declarations of public solidarity with Athens are becoming more frequent. Ms Merkel has greeted suggestions that Germany’s private sector banks should make some sort of gesture – perhaps via declarations they will retain their big Greek holdings – not least because this might help her gain the broadest political support for Berlin’s share of the Greek aid package.
Meanwhile, one of the country’s leading business newspapers has launched a cheeky campaign to boost public support for the embattled Greeks. Assorted German notables, including Hans Eichel, former finance minister, were ready to put their money where their mouth is by buying Greek government paper. Jürgen Grossmann, head of energy giant RWE, says he has purchased no less than €100,000 ($132,000) of Greek bonds.
Such an initiative from the eurozone’s biggest member is to be warmly welcomed. But it probably has more to do with the aspirations of the paper’s new editor than any underlying solidarity with Greece.