Copyright (c) B.Achutha 1992 - 2000 Malaysia

Why do Markets Crash

Why do markets crash? There are probably several reasons for this least of which is panic in the speculative circles. But the objective of this site is to look at mathematical reasons for this type of behaviour rather than emotional reasons. So firstly lets look at models - briefly.

Models

If there ever were common strands that run through all of mankind, it is that need to have some measure of control over his destiny, his need to understand his role in society as a measure of his self respect and self esteem and his dominion over the earth and his enviroment. These come about with knowledge, whether through schooling or through experience and are, in the end, his means of self expression.

Knowledge, whether of the heavens or of the earth, has provided man with some measure of security, sustenance, comfort and companionship. Basic knowledge is an understanding of the behaviour of materials and events. It answers questions such as "Why does it rain in December?", "Why is water a liquid and iron a solid?", "How de we make a pair of jeans?", Where can we catch the biggest fish?", "When will the tide rise?", "When will the aeroplane land?", "When do we plant padi?"....

Knowledge is an understanding of patterns  and patterns of behaviour and responses. We describe these patterns with models. These models may be simple and obvious, learned, heuristic, verbal, pictorial or mathematical depending upon how we describe and communicate these models. Some models may not be true or correct but serve their purpose.

An example of a simple and obvious model is "The sun rises from the East". This is verbal model is self evident or observable every day and hence it is obvious. It is simple because it provides very little information. If we had said "The sun rises in the morning" we would not be describing a modle as by definition morning is the period when the sun rises. "The sun rises from the East" is a model as we can infer from the direction of a shadow which direction is West and use this additional information. For example if you lived very far North of the Equator you would want your house to have a clear view of the South to ensure the building warms with the evening sun. Where as if you lived in the equatorial regions you would choose a site that was in the evening shadow to ensure that sleeping conditions at night were not hot and sweaty.