Journal of Behavioral Finance

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Identifying the Transition from Efficient-Market

to Herding Behavior: Using a Method from
Econophysics

Mara Jos Muoz Torrecillas, Rossitsa Yalamova & Bill McKelvey

To cite this article: Mara Jos Muoz Torrecillas, Rossitsa Yalamova & Bill McKelvey
(2016) Identifying the Transition from Efficient-Market to Herding Behavior: Using
a Method from Econophysics, Journal of Behavioral Finance, 17:2, 157-182, DOI:
10.1080/15427560.2016.1170680

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Published online: 25 May 2016.

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 THE JOURNAL OF BEHAVIORAL FINANCE
2016, VOL. 17, NO. 2, 157182
http://dx.doi.org/10.1080/15427560.2016.1170680

Identifying the Transition from Efcient-Market to Herding Behavior: Using

a Method from Econophysics
Mar
a Jos
~oz Torrecillasa, Rossitsa Yalamovab, and Bill McKelveyc
e Mun
a
University of Almer
a; bUniversity of Lethbridge; cKEDGE Business School

ABSTRACT KEYWORDS
We test whether detrended uctuation analysis (DFA)an econophysics methodidenties the Herding behavior; Identifying
transition from efcient-market trading to herding behavior and the rise of the NASDAQ dot.com herding; Herding-on; -off;
stock market bubble. DFA divides a time series into segments of varying lengths and then tests Dot.com bubble; Hurst
whether power-law distributions exist within the segments. A power-law distribution of stock-price exponent; Econophysics;
Detrended uctuation
Downloaded by [University of Nebraska, Lincoln] at 09:02 28 May 2016

changes within a segment indicates herding behavior and the start of the dot.com bubble. The analysis
clarity of the transition indication depends on both segment lengths and segment starting dates.
Our ndings show that DFA can be used to identify the beginning of stock-market bubbles but not
the beginning of crashes.

Introduction
When does efcient-market behavior turn into herding
behavior? Can the transition point be identied? Gene
Famas [1965, 1970] efcient market hypothesis
(EMH), dating back to Bachliers [1914] random walks,
has dominated nancial theorizing for more than four
decades. In fact, Jain and Gupta produced evidence of
nonrandom walks in the form of herding by banks in
1987, and Lo and MacKinlay showed that stock prices
do not follow random walks in 1988 (p. 1279; see also
[1999]). Not surprisingly, an alternative perspective of
herding behavior (HB) emerged in the 1990s (Scharf-
stein and Stein [1990], Shiller [1990], Banerjee [1992],
Bikhchandani, Hirshleifer, and Welch [1992]).1
Needless to say, research about herding behavior con-
tinues.2 Even so, Cooper ([2008], p. 11) concludes:
Despite overwhelming evidence to the contrary, the
Efcient Market Hypothesis remains the bedrock of how
conventional wisdom views the nancial system.
Despite Coopers observation, HB research continues
(Maskawa [2007], Brown et al. [2008], Lillo et al. [2008],
Choi and Sias [2009], Greenwood and Nagel [2009],
Hott [2009], Elan [2010], Park and Sabourian [2010],
Mendel and Shleifer [2011], Balcilar, Demirer, and Ham-
moudeh [2013], Chen [2013], Lee, Chen, and Hsieh
[2013], Reboredo et al. [2013], Sarpong and Sibanda
[2014], others mentioned later).
If we accept the reality that both kinds of trading
behavior exist (Yalamova and McKelvey [2011]), then
what is missing is any tractable method for identifying the
point in stock trading where the transition between ef-
cient-market behavior (EMB) and HB occurs. Of course,
dramatic market crashes are obvious ends to herd-insti-
gated bubbles. But identifying the transition point from
EMB to HB and the beginning of bubbles remains elusive.
The key to what is now known as resilience engineering
against nancial engineering (Sundstrom and Hollnagel
[2011]) is identifying the transition from efcient-market
(EM) trading to the beginning of HB and the pronounced
bubbles leading to dramatic market crashes.
While herding stock traders gain wealth for some
period of time (Brunnermeier and Nagel [2004]), which
is a positive event, there is often considerable risk to the
broader community when a signicant crash follows; the
Great Recession of 20072009 following the crash of
the bubble based (initially) on U.S. housing prices is the
most obvious recent example. Hence, one can under-
stand the concern of Sundstrom and Hollnagel and their
chapter authors (e.g., Satinover and Sornette [Ch. 6];
McKelvey and Yalamova [Ch. 9]) about nancial-resil-
ience engineering. For the Finance community, it is one
thing to argue about whether EMH is the predominant
paradigmatic explanation of trading behavior, but it is
something else again to accept that both EMB and HB

CONTACT Bill McKelvey mckelveybill1@gmail.com; bill.mckelvey@anderson.ucla.edu UCLA, Anderson School of Management, 110 Westwood Plaza,
Box 951481, Los Angeles, CA 90095-1481.
Bill McKelvey is now a Professor Emeritus at UCLA School of Management.
Color versions of one or more of the gures in the article can be seen online at www.tandf.com/hbhf.
2016 The Institute of Behavioral Finance
 158 M. J. M. TORRECILLAS ET AL.
exist and then look for methods of nding the switch
from EMB to HB.
We offer a methodnew to Finance and herding
researchfor identifying the transition point from EMB
to HB. Our method stems from Econophysics (West and
Deering [1995], Mantegna and Stanley [2000], Chatterjee
and Chakrabarti [2006], Rickles [2011], Sinha et al.
[2011]), a eld that has developed in parallel with herd-
ing research and originated circa 1990. Unlike EMH,
however, which holds that trading behavior consists of
random movements around the mean, that is, the ef-
cient-market price, and may be researched via Gaussian
statistics, econophysicists start with L
evy, Pareto, and
power-law (PL) (long-tailed) distributions. Their per-
spective ts best with the so-called fractal nance
school: Peters [1994], Sornette [2003], Malevergne and
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Sornette [2005], Jondeau, Poon, and Rockinger [2007],
and Calvet and Fisher [2008].
Fractal nance builds from Mandelbrots and the econ-
ophysicists discovery that many, if not all, stock-market
time series are fractal or multifractal; that is, the thou-
sands of short sequences of rising and falling stock prices
have more-or-less the same underlying causal dynamics
and appearance as the smaller number of larger price rises
and falls, and even a major longer-lasting bubble and
more dramatic crash. A variety of studies now show that
price dynamics in various Indices show fractal structures.3
Recently, Yuan, Zhuang, and Liu [2012] found that price
and volatility are correlated in stock markets.
Said differently, the many small-scale price move-
ments have the same geometric pattern as the fewer, but
larger, bubbles and crashes. This is often referred to as
self-similarity (Song, Shlomo, and Makse [2005]) and
fractality/multifractality (Borland et al. [2005], Barunik
et al. [2012], Siokis [2013], Sensoy [2013], Wang and Xie
[2013], Su
arez-Garcia and G
omez-Ullate [2014]). A PL
distribution of stock-price changes appears as a straight
line if plotted using log X- and Y-axes; that is, it takes the
form of a rank/size expression, F N b, where F is fre-
quency, N is rank (the variable), and b, the exponent, is
constant. In cases of multifractality b varies with scale.
We begin by pointing to the reality that HB is also
fractal because herds mirror social inuence patterns that
are networks of inuences in which some nodes (traders,
ofces, banks, rms) have rather pervasive inuence;
many other nodes are just lone followers in the herd. It is
now well known that networks are fractal structures;4 as
described in more detail later. To date, however, we have
yet to nd any network-based study that actually tries to
identify the transition point from EMB to HB.
As we elaborate below, since complex herd networks
of market participants synchronize their trading in a
bubble-build-up regime, stock-market time series are
both fractal and PL distributed. We theorize that the
emergence of a fractal structure in a stock-market time
series indicates the underlying presence of HB. For our
empirical conrmation we use the most popular current
method from econophysicsdetrended uctuation
analysis (DFA)to see how well and how early it can
detect the emergence of herding in the well-known and
obvious bubble-build-up of the NASDAQ Composite
(more than 3000 components) that led to the famous
dot.com crash starting in 2000. When it peaked at 5,132
on March 10, 2000, the NASDAQ was 500% above its
1995 level; after it crashed it dropped to 1,185. At its
peak the herding bubble was $4.4 trillion higher than
after the crash (Goldfarb, Kirsch, and Miller [2007]). We
use this NASDAQ time series (starting January 4, 1993)
for two reasons: (1) It was dominated by the initial trad-
ers speculation on the growth of a new industry (dot.
com rms) and ended in a dramatic crash and loss of
value, and (2) it is a much-less random mix of rms than
is true of the S&P or Dow Jones indices.
We nd that: (1) By December 1994, dramatic empiri-
cal evidence indicates that HB exists among NASDAQ
traders and that the Hurst exponent, H, continues as a
solid indicator of the presence of HB thereafter; (2) The
earliest indications of HB occur before there is any
meaningful evidence that a bubble is about to begin; (3)
By November 1995, eight strong signals appear indicat-
ing that the transition from EMB to HB has occurred;
(4) Although DFA appears to be a useful method for esti-
mating H and hence for identifying HB, segment lengths
and starting dates are critically important; (5) DFA does
not appear to be a useful method for identifying the
beginning of an impending market crash; and (6) The
dilemma is that although shorter segments offer earlier
evidence of HB, they are also inconsistent in that they
also show that herds can be on and off in HB as the
market time series progresses.
We begin with short denitions of market dynamics
as dened by EMH (Fama [1965, 1970, 1998]). Next, we
focus on how markets transition from efcient markets
(EMs) to bubble-build-ups and crashes. Following this,
we introduce econophysics and dene key elements,
including fractals and PLs. Then we briey review the lit-
erature using HB to explain bubbles in stock markets,
also making the case that herding (rule-based trading
and imitation) accelerates in complex information envi-
ronments when gathering or processing information is
costly (Yalamova and McKelvey [2011]). More speci-
cally, we theorize that herding emerges from social net-
works, which appear as Pareto and PL distributions.
From this base, we argue that the most popular method
from econophysics, DFA, becomes a valid means for
identifying stock-market transitions from EMB to HB
 THE JOURNAL OF BEHAVIORAL FINANCE 159

and bubble build-ups toward the crash point. We apply Introduction to econophysics
DFA analyses to the NASDAQ doc.com bubble and
Rosser [2008] notes the long historical rooting of eco-
crash time series from January 4, 1993, to July 26, 2002.
nomics in physics. What makes econophysics different,
The DFA method shows that HB denitely exists during
however, are two key elements: (1) Its strict focus on
the doc.com bubble but evidence of HB depends on just
empirical ndings about databases and (2) its emphasis
how the DFA method is applied. A conclusion follows.
of L
evy and Pareto distributions and scalability instead
of statistical mechanics, marginalism, and Gaussian sta-
From the efcient market hypothesis tistics. Though early PL discoveries date back to Pareto
to econophysics [1987], Auerbach [1913], and Zipf [1929, 1949], the
term econophysics was neologized by Eugene Stanley
In this section, we start with a quick reference to Eugene
in 1995 at a conference on statistical physics in Kolkata,
Famas [1965] well-known efcient market hypothesis
India. Since then econophysicists have discovered an
and then turn to econophysics, which abandons Bache-
array of ndings about PL-distributed economic phe-
liers [1914] view of stock markets as random walks in
nomena. Instead of nding that economic phenomena
favor of Pareto [1897] long-tailed distributions, fractals,
invariably trend toward equilibrium, they nd all kinds
and PLs. Specically, we focus on the transition from
of ndings to the contrary, as indicated in the works
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EMB to bubble-build-ups (see also Yalamova and

listed below.
McKelvey [2011]).
While the econophysics ndings are mostly empirical,
the theoretical bases for explaining why PL distributions
Efcient markets exist in nancial economics dates back to Mandelbrots
works of 1963 and 1983.7 Some of the empirical studies
Classic nancial economics dates back to three dominant
focusing more specically on nancial economics and
nance paradigms, the efcient market hypothesis
markets are:
(EMH; Fama [1970, 1998]), the capital-asset pricing

Returns in nancial markets: Mantegna [1991],
model (CAPM; Sharpe [1964], Lintner [1965], Black
Gopikrishnan et al. [1999], Sornette and Johansen
[1972]), and the Black-Scholes [1973] options-pricing
[2001], and Stanley, Plerou and Gabaix [2008].
model. As Mandelbrot and others have noted for deca-

Economic shocks and growth rates: Canning et al.
des, transitions from efcient markets to correlated
[1998], Stanley, Amaral, and Plerou [2000],
trader behaviors and bubble-build-ups to market crashes
Ormerod and Mouneld [2001], Podobnik et al.
occur far more often than expected (Mandelbrot [1963,
[2006], and Redelico, Proto, and Ausloos [2008].
1968, 1983], Lo and MacKinlay [1988], Peters [1994]).

Stock market volatility dynamics: Arn
eodo, Muzy,
Even so, according to Fama [1998], until a new and bet-
and Sornette [1998], Muzy, Bacry, and Arn
eodo
ter paradigm is put forth, one cannot criticize EMH/
[2001], Ellis and Hudson [2007], Kang and Yoon
CAPM. Fama reduces behavioral nance and trading
[2007], and Jiang et al. [2010].
dynamics to anomalies and over-/under-reaction epi-

Detecting stock market bubbles and predicting
sodes that are normally distributed and irrational. By
crashes: Grech and Mazur [2004], Couillard and
now, however, additional evidence has become available
Davison [2005], Sornette and Zhou [2006], Mas-
showing that markets oscillate between efcient market
kawa [2007], Alvarez-Ramirez et al. [2008], Czar-
behavior and nonrandom fractal behaviors.5
necki, Grech, and Pamula [2008], Du and Ning
The Economist ([2009], p. 70) observes that we now
[2008], Eom et al. [2008a, b], and Chen [2013].
know that the 25-year Great Moderation period has

Using big data to anticipate early warning signs:
ended, in which macro- and nancial economists blithely
Preis, Reith, and Stanley [2010], Balcilar et al.
presumed that their independent, identically distributed
[2012], Bordino et al. [2012], Preis et al. [2012], Ala-
(i.i.d.), normal-distribution assumptions of efcient-mar-
nyali, Moat, and Preis [2013], Moat et al. [2013],
ket trader and asset-pricing behaviors and consequent
and Preis, Moat, and Stanley [2013].
theoretical and quantitative models offered inevitably cor-
rect views of real-world market behavior. The Economist
continues by observing that the Long-Term Capital Man-
Dening fractals and PLs
agement debacle and the 20072008 liquidity crisis both
demonstrate just how quickly supposedly uncorrelated Econophysics main contribution is the empirical discov-
asset-price movements can become highly correlated, ery of just how often non-Gaussian distributions are the
leading all traders toward the same buy/sell motivations, best descriptions of socioeconomic behaviors by self-
which then leads to a market bubble and crash.6 organizing agentspeople and social systems, stock
 160 M. J. M. TORRECILLAS ET AL.
traders, stock markets, and nancial systems. Key ele-
ments are fractal structures, PLs, and scale-free theory.
In his opening remarks at the founding of the Santa Fe
Institute, Gell-Mann [1988] emphasized the search for
scale-free theoriessimple ideas that explain complex,
multilevel phenomena. Brock [2000] goes so far as to say
that scalability is the core of the Santa Fe visionno
matter what the scale of measurement, the phenomena
appear the same and result from the same causal dynam-
ics. Gell-Mann [2002] concludes his chapter, What is
Complexity? with a focus on scalability in living
systems.
Fractals
Consider the cauliower. Cut off a oret; cut a smaller
oret from the rst oret; then an even smaller one; and
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then even smaller, and so on. Despite increasingly
smaller size, each smaller oret performs the same func-
tion and has roughly the same design as the oret above
and below it in size. This feature denes it as fractal.
Fractals can result from mathematical formulasas
shown in Mandelbrots Fractal Geometry [1983]. We are
more interested in fractal structures that stem from
adaptive processeslike the cauliowerin biological,
social, and nancial contexts. In fractal structures the
same adaptation dynamics appear at multiple levels.
McKelvey, Lichtenstein, and Andriani [2012] cite 19
studies showing adaptation-based predator/prey fractal
dynamics. Zanini [2008] argues that the same effects
hold for merger and acquisition activities in business
niches.
Fractal structures are often indicated by PLs. The
econophysicist Barab
asi [2002] connects scalability, frac-
tal structure, and PL ndings to social networks. He
shows how networks in the physical, biological and social
worlds are fractally structured such that there is a rank/
frequency effectan underlying Pareto distribution
showing many sparsely connected nodes at one end and
one very well connected node at the other. For example,
if plotted on a double-log graph, the Pareto-distributed
progression of increasing numbers of connections from,
say, small airports to giant ones like Heathrow and
Atlanta, appears as a negatively-sloping straight line.
PLs
A well-formed Pareto rank/frequency distribution plot-
ted in terms of double-log scales appears as a PL distri-
bution. The now famous PL signature dates back to
Auerbach [1913] and Zipf [1929, 1949]. Andriani and
McKelvey [2007, 2009] list roughly 140 kinds of PLs in
physical, biological, social, and organizational phenom-
ena. Stanley et al. [1996] and Axtell [2001] nd that
manufacturing rms in the United States show a fractal
structure.8
Since PLs mostly appear to be the result of self-organi-
zation, they often if not always signify active self-organi-
zation processes at work maintaining some kind of self-
organized criticality9 (Bak [1996]). Thus, Ishikawa
[2006] shows that PLs represent adaptive and changing
industries as opposed to static ones. Podobnik et al.
[2006] show PLs in the stock markets of transition econ-
omies. The Dow Jones market capitalizations of the 30
largest U.S. publicly traded rms show a PLagain, evi-
dence of fractals when traders are free to buy and sell as
they wish (Glaser [2012]).10 Iansiti and Levien [2004]
show that the software industry is the most resilient
across the 2002 dot.com bust. Compared to the chemi-
cals, machinery, and utilities industries, Zanini [2008]
and Glaser [2012] show the software industry to be
much more Pareto distributed.
Scale-free theories aim to explain scale-free causal
dynamics. Newman [2005] and Andriani and McKelvey
[2009] offer extensive discussions and descriptions of
many scale-free theories. Space precludes pursuing this
topic here.
Using PL distributions to identify HB
We now turn to review the literature on HB by
Bikhchandani and Sharma [2001] and Hirshleifer and
Teoh [2003] and update them. Next we point out that a
number of studies show that herding is based on social
and/or observational networks and, furthermore, that
networks are frequently PL distributed. These set up PLs
as a means for identifying the beginning of herding-
based stock-market bubbles, which gives us a basis for
using the DFA method to identify the transition from
EMB to HB, that is, identify the beginning of stock-mar-
ket bubbles.
Characterizing herding behavior
The study of herding behavior in stock markets dates
back to Jain and Gupta [1987] and Lo and MacKinlay
[1988]. By 2001 Bikhchandani and Sharma cite 51 works
discussing herding behavior in connection with stock
markets, traders, analysts, investors, mutual fund manag-
ers, and so on. They mention information-based herding
and cascades as well as reputation- and computation-
based herding. Despite all their citations, the authors
conclude that in developing countries the evidence
suggests that investment managers do not exhibit signi-
cant herd behavior. They suggest herding is more likely
in emerging markets. They also conclude that empirical

studies are not very accurate in identifying true herding
behavior.
Hirshleifer and Teoh [2003] conduct a second even
more comprehensive review, citing some 165 works
focusing on nance-relevant herding. Their focus is
on convergence or divergence brought about by actual
interactions between individuals (p. 27, their italics).
Hirshleifer and Teoh argue that convergence in buy/sell
behaviors can be due to:

Network-based payoff externalities;

Dissidents sanctioned by authorities such as
dictators;

Personal preferences for buying one stock versus
random others;

Specic information becoming available about
which stock is to be preferred; and
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Observing the buy/sell actions of other people.
Observational buy/sells can be further differentiated:

Herding together or dispersing apart;

Buy/sell decisions based on observing what other
traders are doing;

Rational observations (Bayesian inference) as
opposed to seeming irrational behaviors; and

Information cascades, which are buy/sell decisions
based on what more and more other people appear
to be doing.
Given Hirshleifer and Teohs ndings that most
nancial economists have concluded that herding behav-
ior is basically irrational, they offer a set of reasons why
rational individuals abandon their own private informa-
tion about fundamental values and, instead, jump tem-
porarily on the herding bandwagon ([2003], p. 32):

Idiosyncrasy: Increasing numbers of traders fol-
low a few initial buy/sell signals;

Fragility: By the time a clever initiating idea loses
its captivating luster the network-based cascade of
buying/selling has taken off;

Simultaneity: Endogenous or exogenous circum-
stances causing buy/sell delays create tensions that
nally dissipate resulting in chain reactions, stam-
pedes, or avalanches as traders then rush to
jump on board the bandwagon;

Paradoxicality: Traders in cascades simply ignore
countervailing information as long as the herd
appears to keep growing; and

Path dependence: Positive-feedback dynamics
based on random, insignicant initial buy/sell
events give rise to increasing payoffs which then
become so attractive that traders get locked-in; that
is, they are more reluctant to jump off the band-
wagon (Arthur [1989]). The positive-feedback ratio-
nale is emphasized in more recent papers as well
(Hott [2009], Jeon and Moffett [2010]).
THE JOURNAL OF BEHAVIORAL FINANCE 161
Research about the presence and rationales for herd-
ing in nancial markets has continued since the Hirshlei-
fer and Teoh review.11
Although Bikhchandani and Sharma [2001] cite 51
nance-related herding papers and Hirshleifer and Teoh
[2003] cite 165 similar works, they primarily focus on
identifying HB after it exists, and then argue about
whether HB is rational or irrational. More recently
research is emerging that empirically connects herding
to changes in stock markets (e.g., Gleason, Lee, and
Mathur [2003], Gleason, Mathur, and Peterson [2004],
Blasco, Corredor, and Ferreruelaa [2010, 2011], Chiang
and Zheng [2010], Demirer, Kutan, and Chen [2010],
Demirer and Ulussever [2011], Al-Shboul [2012], Balci-
lar, Demirer, and Hammoudeh [2013], Chen [2013],
Gebka and Wohar [2013], Kukacka and Barunik [2013],
Bohl, Klein, and Siklos [2014], Demirer, Kutan, and
Zhang [2014], Sarpong and Sibanda [2014], Yao, Ma,
and He [2014]).
Nowhere in this literature, however, do we see any
empirical method proposed or used that actually identies
the transition point between EMB and HB, that is, the
beginning of HB; a recent exception is Domino [2011].
Herding viewed from other disciplines
Rook [2006] takes the position that herd behavior, how-
ever, cannot be fully understood from a single perspec-
tive alone (p. 75). Economists focus on choices herding
produces, especially those related to long-term effects
and benets obtained. Rook also notes that although
economists picked up the social-network approach in
the 1970sinuenced by the sociologist Granovetter
[1973]he also says that the core assumptions underly-
ing [economists use of] the network effect were the exis-
tence of complete information and rational actors
(p. 79).
Psychologists, on the other hand, study motivations
underlying herding behaviors that emerge. Rook con-
cludes: In sum, herd behavior in social psychology was
initially understood as an irrational and unconscious
process. He ends his article, by advocating an
integrative economic psychological approach to herd
behavior. An integrative economic psychological
approach could yield detailed insights into the accuracy
of motivations underlying individual and group deci-
sions to partake in herd behavior. It thus not only helps
in assessment of the ways in which decision makers
should deal with herding pressures within institutions
but also in the estimation of how much institutions could
benet from either partaking in or avoiding herd behav-
ior (p. 91; our italics). For a very psychological review of
trading behavior, see Birau [2012].
 162 M. J. M. TORRECILLAS ET AL.
Not unsurprisingly, we nd that various authors have,
indeed, been studying just what Rook concludes; they
have taken a more institutional perspective. Cooper
et al. [2001] present evidence showing that analysts fore-
casts correlate with recent stock price performance.
Greenwood and Nagel [2009] nd that young, inexperi-
enced fund managers are trend chasing and are much
more prone to herding behavior. Finally, Choi and Sias
[2009] show that there is strong herding in the institu-
tional investment industry. They also nd six kinds of
herding: underlying investor ows, institutional positive
feedback trading, attempting to preserve reputation by
acting like other managers (reputational herding), infer-
ring information from each others trades (informational
cascades), and following correlated signals (investigative
herding) (p. 469). Hott [2009] and Jeon and Moffett
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[2011] emphasize positive feedback. Baddeley [2010] fur-
ther develops Rooks economic/psychological multidisci-
plinary discussion by adding in personality, emotions,
and moods, as well as sociology and social interdepen-
dence applied to herding, evolutionary biology and herd-
ing instincts, and nally she uses interacting brain
systems to explain HB.
A socionomic approach taken by Parker and
Prechter ([2005]; see also Prechter [1999, 2001]) offers a
somewhat differentbut relatedalternative to Rooks
integrative economic psychological approach. Drawing
on Shiller [1990, 2000, 2002] and Paretos sociological
theory and nonrational instincts (summarized by Zetter-
berg [1993]), Parker and Prechter review existing herd-
ing theories based on: (1) social psychologyimitation,
fads, fashions; (2) information theorycascades, positive
feedback; (3) ethologyocking, migration, ants; (4)
econophysicschaos theory, self-organized criticality,
fractals; and (5) medical modelsinfection, disease con-
tagion. They emphasize the impact of uncertainty on
traders; prerational aspects of brain functioning (Paretos
six nonrational instincts), unconscious mental processes
that underlie investment decisions; and the dominance
of endogenous causality. Socionomics is based on evolu-
tionary theory in that herding developed via evolu-
tion to enhance survival (p. 6). In short, socionomics
emphasizes that herding is a humanmarket trader
survival instinct.
PL distributions of social and/or observation
networks
We begin this section by focusing on three recent studies
showing the extent that stock-market participation is a
direct function of social networking. Hong, Kubik, and
Stein [2004] nd that social interaction does indeed lead
to stock market participation. If my friends are doing it,
then why not me? Local interaction effects on herding
are also found by Cajueiro and De Camargo [2006].
Maskawa [2007] uses a virtual market to show that
mimetic behavior of traders produces a PL distribution
(which we pick up on next). Given these three studies, it
is not surprising to nd that Neighbors Matter, which
is the title of Brown et al.s [2008] article. They nd that
the predilection of an individual to participate in stock
purchases is a direct outcome of the extent to which his/
her neighbors buy stocks. Again, this points to the
importance of word-of-mouth [also word-of-web
(Escofer and McKelvey [2015]) communication, which
is also a function of the nature of the social network peo-
ple are embedded within.
Maskawa [2007] also develops a virtual market to
show that stock-price uctuations are based on mimetic
(herding) behavior. In doing this, he draws on preferen-
tial attachment, a well-known scale-free theory and
cause that gives rise to PL distributed networks (see also
Barab
asi [2002], Newman [2005])as nodes become
larger they become more attractive, as in the rich get
richer or in hub-and-spoke airports.
Many studies now show that networks are fractal
PL-distributed structures (DeSolla Price [1965]): collabo-
ration networks (Newman [2001]); various kinds of net-
works (Moss [2002]); scale-free networks (Barab
asi
[2002]); industrial clusters (Andriani [2003]); moviegoer
networks (De Vany [2003]); organizational networks
(Dodds, Watts, and Sabel [2003], Watts [2003]); director
networks (Battiston and Catanzaro [2004]); social net-
works (Cs
anyi and Szendro

i [2004], Hamilton et al.
[2007]); shocks (Sornette et al. [2004]); alliance networks
(Gay and Dousset [2005]); network dynamics (Powell
et al. [2005]); company networks (Souma et al. [2006],
Chmiel et al. [2007]); online networks (Mislove et al.
[2007]); interrm relationships (Saito, Watanabe, and
Iwamura [2007]); degrees of connectivities (Santiago and
Benito [2008]); investment networks (Song, Shlomo, and
Makse [2009]); communication ability (Zhai, Yan, and
Zhang [2013]); nancial markets (Nobi et al. [2013]);
stock-based networks (Hu, Qi, and Wang [2013]); eco-
nomic sectors (Hu, Yang, Cai, and Yang [2013]; and
buyer-supplier networks (Mizuno, Souma, and Wata-
nabe [2014]). A different kind of study showing how
communications among people form a PL distribution is
by Gerow and Keane [2011]; they analyze nancial com-
mentaries in newspaper websites.
Using a well-designed agent-based computational
model initially calibrated to reproduce Gaussian-distrib-
uted EMH behavior in their model stock market, Lamba
and Seaman [2008] ndusing the DFA methodthat
when they characterize some agents with a threshold-
type herding tendency, the few agents initial tendencies

to copy each others trading behavior eventually spreads
to the point where a PL distribution appears and the H
exponent reaches 0.86 (dened in the following section).
Lamba and Seamans results follow the classic philoso-
phy of sciences counter-factual conditionali.e., If X attempt to identify the transition between EMB and
were to occur, Y would occur (Bennett [2003]). In Sec-
tion 3 we develop a theoretical basis for using PLs to
indicate HB. In counterfactual language, our research
design tests the following sequence: If PL-distributed
trading behavior were to exist then HB would exist and
then a stock-market bubble would emerge over time.
We now develop our rationale for using the DFA
method of identifying the beginning of HB. The logical
sequence of our analysis is, therefore:
1. HB causes the transition between EMs and bubble-
build-ups to crash points.
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2. Social and/or observation network dynamics give
rise to HB.
3. Such networks typically take the form of PL
distributions.
4. Networking, that is, herding, creates PL distribu-
tions of stock-market price movements; they
appear as rank/frequency PL distributions ranging
from thousands or more tiny price changes from
day-to-day or week-to-week to fewer and fewer but
larger and larger price changes.
5. The build-up of PLs, then, becomes a usable
method for identifying the transition between the
random price-changes due to EMB versus PL
described price-changes due to HB and thence the
beginning of bubble-build-ups.
6. We use DFA to identify the beginning of HB in the
famous NASDAQ dot.com bubble-build-up.
NASDAQ data, bubble segment, dening Hurst
exponent H and DFA method
We begin by documenting the fact that a number of
econophysicists have applied various methods to stock
market analyses. Then we dene the segment of the
NASDAQ stock market we draw data from. Next we
dene the Hurst exponent, H. Following this, we dene
the DFA (detrended uctuation analysis) method.
Trying to predict stock-market bubbles and crashes
In a paper titled Multi-scaling in Finance, Di Matteo
[2007] reviews several competing methods created in
econophysics that are used to study the multifractal12
structure of stock-market time series.13 Some econophys-
icists, however, more explicitly zero in on trying to actu-
ally predict the occurrence of crashes once stock-market
bubbles have formed. In addition to studies listed earlier,
THE JOURNAL OF BEHAVIORAL FINANCE 163
we point to: Yalamova [2003, 2010]; Gneiting and
Schlather [2004]; and various others.14
What seems strange is that we do not nd any
empirical studies (in any discipline) that actually
HB as a way of identifying the beginning of stock
market bubbles, let alone as a method from econo-
physics (or any other discipline) to do so. While there
are many studies nding multifractality and multiscal-
ing extending across multiyear nancial time series,
none of them attempts to identify the emergence of
the rst fractal in a nancial time series, which would
be the rst indication that EMB has switched to PLs,
fractal structure, and HB. All the studies attempting
to predict crashes aim to identify the end of bubbles,
not their beginning. In reality, stock-market traders
dont really care about multifractality. While predict-
ing crashes is obviously important, there are also
many trader-advantages gained from identifying the
end of EM trading as it transitions into HB and bub-
ble-build-up.
Consequently, we use DFA to try to identify the
beginning of HB and the beginning of the emergent
stock market bubble in the NASDAQ time series starting
January 1993.
Dening the NASDAQ bubble data segment
We begin by noting that Greenwood and Nagel [2009]
observe that stocks most affected by the dramatic bubble
and crash of the NASDAQ before and after March 10,
2000, were in the Internet and technology sectors. This
said, however, they then use the price/sales ratio
(p. 241) of rms in several SIC code technological indus-
tries to further limit their NASDAQ analyses to the
larger rms in SIC-identied technology industries.
They do this since they are focusing on fund managers
as opposed to the broader mix of traders.
We use the entire NASDAQ Composite, which
includes more than 3,000 components. Even so, we
choose the NASDAQ because it is a more focused index
instead of one explicitly designed to be a random mix of
various kinds of rms, such as the Dow Jones and S&P
indices. At this point in time, we prefer to use a focused
index, but not zero in on a subset of specic kinds of
rms. The latter seems relevant for Greenwood and
Nagels study of fund managers, but for our more general
search for the beginning of bubbles the Composite index
is more appropriate. Unlike Greenwood and Nagel, how-
ever, who focus on the timeframe of December 1997
through December 2002, we analyze the market from
January 4, 1993 to July 26, 2002. We try to start our anal-
yses before the dot.com herding bubble started.15
 164 M. J. M. TORRECILLAS ET AL.
Dening the DFA (detrended uctuation analysis)
method
At this point in time the most popular method, which we
choose, is DFA (Peng et al. [1994, 1995], Ausloos et al.
[1999]).16 After statistically testing the relative accuracies of
three competing methods, Weron [2002] concludes that
the DFA statistic turns out to be the unanimous winner
(p. 285; our italics). In stochastic processes, chaos theory,
and time series analysis, DFA is most useful for determining
the statistical self-similarity (i.e., fractal or PL structure) of a
time-series in which the data points are stock-market price
changes. DFA is useful for analyzing time series in which
changes could be PL distributed, such as social networks,
i.e., herd-based, stock-price changes.
The generalized Hurst exponent, H originated in
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Edwin Hursts classic article of 1951, in which he
describes his studies of volatile oods and droughts
in the Nile river valley. The Hurst exponent is nonde-
terministic in that it expresses what is actually
observed in nature; the econophysicists all say that it
is not actually calculated but rather is estimated.
Starting in 1968, Mandelbrot recognized the implica-
tions of Hursts method of analysis for fractal repre-
sentation of real-world phenomena (Mandelbrot
[1983]). Writing about fractal structures in all kinds
of phenomena (Schroeder [1991], Peitgen, J urgens,
and Saupe [1992/2004], Hastings and Sugihara
[1993], Mandelbrot [2010], Wang, Ziang, and Pandey
[2012], Pav
on et al. [2013], Sensoy [2013], Siokis
[2013], Su
arez-Garcia and G
omez-Ullate [2014]) has
proliferated in recent years, especially in fractal
nance, as many of our foregoing econophysics cita-
tions indicate. H has become the predominant out-
come variable of DFA analyses.
The best originating sources of DFA are Peng et al. [1994,
1995] and Taqqu, Teverovsky, and Willinger [1995]. The
Figure 1. Depicts how the within-segment OLS-dened trend lines differ. Shows the R2 ts of price deviations around within-segment
trend lines as well as H values for several of the 25-week DFA segments before and after the crash (Friday of week 300 is September 25,
1998; Friday of week 400 is August 25, 2000). Note that the R2 and H values are not correlated and that HB disappears in the segment
of weeks 325350; HB temporarily dissipates into EMB in this segment, which comes some three years after HB appears to have started.
most straightforward more recent descriptions of the DFA
method are given by Weron [2002] and Delignieres, Torre,
and Lemoine [2005]. Details of the method they describe
are presented below, with some further elaborations by us.
Step 1: Create a cumulative time series:
X
k
y.k/ D x.i/ (1)
iD1
We use NASDAQ weekly closing prices from Friday,
January 8, 1993 to Friday, July 26, 2002. For us, k D
number of weekly (total D 500) closing prices in our
NASDAQ time series, y. As noted earlier, Yuan, Zhuang,
and Liu [2012] nd that price and volatility changes are
correlated, even in multifractal stock markets.
Step 2: Create time-series segments: The cumulative
time series y(k) is divided into a set of d non-overlapping
time-series segments (often called boxes in the DFA lit-
erature) of equal-length n; d n D L, the total length of
the time series being L.
Step 3: Calculate OLS ts for each segment: Using
price-uctuations within a segment, calculate the least-
squares line that ts the data. This is the trend line
within the segment. The example R2 values we show in
Figure 1 indicate whether the uctuations within a seg-
ment are large or small.
Step 4: Detrend the cumulative time series, y(k), by cal-
culating price-uctuation deviations above or below the
within-segment trend line for each Fridays closing price:
v
u L
u1 X
F.n/ D t y.k/ yn .k/2 (2)
L kD1
In this step, all price uctuations within all the seg-
ments are now represented as deviations above or below

the OLS trend line within each specic segment. This
computation is repeated over all time scales (i.e., all seg-
ments of all lengths) to identify F(n), the average uctua-
tion within each of the d segments having similar length,
n (each segment can have a different trend line).
The time series is subdivided into a set of d segments,
some of which we illustrate in Figure 1 (actual segments
are not shown, just the OLS lines within the segments):
Figure 1 highlights the Hs of the 25-week segments (i.e.,
of length n) before and after the crash; each of the seg-
ments has to be further subdivided into 2 subsegments,
then 4, then 8 subsegments of 12, 6, and 3 weeks each
(not shown) to calculate H. After OLS creates the trend
line for each segment, the R2 numbers indicate how close
the price uctuations are to the trend line.
Step 5: Calculate H: Peng et al. [1995] place of all of
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the longer- and shorter-segment OLS-deviation values
on the Y-axis (using the log value of the average of all
uctuations, F(n), within each of the d segments of the
same length, n, as the entriessmallest segment values
are nearest to the origin). They locate segment-length on
the X-axis (using the log of segment length), with the
shortest similar-sized segments nearest the Origin and
the longest segment (containing all of the subdivided
shorter segments) out at the right-hand end of the
X-axis. By doing this they set up conditions that create
the rank/frequency distribution (if it is present in the
data) underlying all PL graphs.17 Their DFA method
arranges the data such that the PL distribution will
emerge as an inverse sloping straight line if the time-
series data within a given segment are, in fact, PL
distributed.
Because of HB, Peng et al. [1995] note that longer seg-
ments will typically contain larger price uctuations take this to be evidence of positive-feedback20 based HB
around the OLS within-segment trend linethat is, if
the herd develops and starts collective buying and selling
behaviorwhich also means that the average deviation
value will appear higher up on the Y-axis. When the
time series is subdivided into many shorter segments, for
example, d D 32, each segment-average is based on many
fewer price uctuations and absent HB-based positive-
feedback inuences, they will typically show much
smaller OLS deviations and, therefore, be positioned
lower on the Y-axis near the origin. By using the binary
divisor and log scales, Peng et al. create the conditions
such that the data, when plotted in a double-log graph,
will create the classic inverse-sloping PL straight line. As
the OLS deviations in the longest segment become larger,
relative to the average OLS deviations in the increasing
number of smaller segments, the PL slope gets steeper
and H increases above 0.50. This because the probability
is that the longest segment will have the largest number
of large price deviations away from the OLS trend line.
THE JOURNAL OF BEHAVIORAL FINANCE 165
By the foregoing process, the DFA method typically (but
not always) produces a positive sloping a plot line with
its lower end toward the Originas illustrated in
Figure 2.18
The angle of the sloping line to the X-axis gives us the
estimated19 value of H (based on a), the exponent rep-
resented in formula 3, where: n is segment length; F(n) is
the average uctuation; c is a constant:
F n  cna : (3)
Given that the stock-market time series is fractal
Brownian motion, we obtain the estimated value of H
from the following equation (Delignieres, Torre, and
Lemoine [2005]):
H D a 1: (4)
As one may see in Figure 2, the two sloping lines that
show the highest H values are slightly steeper than the
other slopes. Since the several H values are more dramati-
cally different than the angles of the slopes, the econo-
physicists have come to focus on H as the exponent rather
than a. Since the H exponent can only range between 0.0
and 1.0, the H D 0.2 and H D 0.87 are extreme values;
although the a slopes are somewhat different, they dont
give any indication of being extreme. An H D 0.5 is an
indication of white noise, i.e., randomness.
An H increasingly higher than 0.5 (econophysicists
call this persistent behavior) indicates the presence of
fewer, but ever-larger deviations away from the OLS line
(i.e., traders intensify their herding behavior); these devi-
ations result in a PL rank/frequency distribution. We
in the stock market. A value of H less than 0.5 (called
anti-persistent behavior) indicates a market systemati-
cally reverting to the long-term mean and/or reversing
itself more consistently than a random market, i.e., EM
traders whose frequent alternating buying and selling
keeps the market price continually approximating the
fundamental value of a rms stock.
Step 6: Find optimal segment length: There is an opti-
mal segment length: if they are too short (e.g., one month
long) they could just show random variance; if they are
too long they could also lose their unique distinguishabil-
ity; i.e., the appearance of a strong upturn could be com-
bined with strong downturn, with the result that H could
also appear in the 0.5 range even though HB is strong
both up and down (illustrated later in Figure 5, which
shows that when a segment contains dramatic ups and
downs in the stock chart the R2s are near zero and the
Hs are 0.5). Steps 25 need to be repeated for different
starting dates and segment lengths to nd the optimal
 166 M. J. M. TORRECILLAS ET AL.
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Figure 2. Shows the a slopes calculated for several DFA segments (shown in Figure 3). Although the a slopes appear not all that differ-
ent compared to some of the estimated H exponents (H D a 1; Hs shown in the callout boxes) are quite extreme, since the H expo-
nent is limited to a range of 0.00 to 1.00. a slopes and H exponents are shown for Figure 3 segments as follows (from top to bottom):
H D 0.76 (diamonds; row g in Fig. 3), H D 0.31 (dots; row h in Fig. 3), H D 0.49 (squares; row b in Fig. 3), H D 0.02 (triangles; row a in
Fig. 3), and H D 0.87 (crosses; row b in Fig. 3). The top two slopes are for 100-week segments; the bottom two slopes are for 25-week
segments; the middle slope is for a 50-week segment. Since the Hs are more discriminative than the a slopes, econophysicists prefer to
use Hs to identify herding.

segment length, n, and segment-starting dateas are
clearly indicated in Figure 3.
We have an additional concern about segment length.
With his model, Weron [2002] studies segment-length
samples ranging from 256, to 512, to 1024, to 2048
(e.g., doubling in size) up to 65,536. Obviously, for
statistical purposes large samples are useful. Our NAS-
DAQ time series from January 4, 1993 through July 26,
2002, however, contains roughly 2,500 daily closing pri-
ces (500 weeklies) and includes the bubble and crash. If
we studied 10,000 daily prices we would lose our test-
base of the single well-recognized NASDAQ stock-
market bubble. Furthermore, the two following observa-
tions are worth noting:
First: Domino [2011], who uses daily price uctua-
tions, doubles the number of data points simply by
including daily opening prices as well as closing prices.
Each day has two data points, and the number of data-
points in each segment is doubled. While this appears as
an advantage for using dailies, we will show later in
Table 2 that weekly prices are sharper indications of HB,
even though there are fewer of them.
Second: While our use of weeklies in short segments
(our shortest segments have only three data points)
 THE JOURNAL OF BEHAVIORAL FINANCE 167
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Figure 3. Alignment of the DFA segments of various lengths and starting dates associated with the rise and fall of the NASDAQ stock
chart during the time of the dot.com Bubble and Crash. NASDAQ Index values listed on the Y-axis (left-side); weeks listed on the X-axis;
rows listed on the right-side. Segments showing H exponent values above 0.56 are underlined and in bold. Numbers at the bottom indi-
cate the weekly progression of Friday closing prices. This graph shows how dependent the H values are on segment length and starting
date. By week 150, however, eight segments of different lengths show Hs at 0.6 or higher. Dates of each 25-week time and actual price
changes are shown in Table 1.

seems prone to random error, it is important to note that
as segments get shorter there are more of them being
averaged together. For example, suppose the longest seg-
ment-length has 100 weekly data points; the shortest seg-
ment then has only three weekly prices in it; but there are
33 of the shortest segments; the total data points upon
which the Y-coordinate is basedthat is, 3 32 D 96 C
4 (one segment has 4 weeklies in it)is the same as the
number of data points in the longest segment, 100.
Because of the small segment size, it is possible that each
individual-segment OLS root-mean-square value could
be questionable, but when 33 of them get averaged
together the total database is the same as for the longest
segment. In short, the total database for each entry on
the Y-axis in Figure 2 is the same.
The dilemma: Our objective is to try to identify the
beginning of the NASDAQ bubble sometime after January
4, 1993. This creates a dilemma: (1) On the one hand, the
shorter the segments, the sooner we can identify
the beginning of the bubble (assuming, of course, that the
NASDAQ bubble is based on herding and positive feed-
back or other scale-free causes); (2) On the other, the
longer the segment, the more shorter segments we have,
the more data points we have in each shorter segment,
the more solid is the basis for determining H, and statisti-
cal credibility improves. Since traders, however, are look-
ing for increased probabilities that HB has begunrather
than some kind of scientic truthshorter segments are
preferable, but only as long as their H results do not
appear to be error prone, needless to say.
DFAKey Points: (1) We cite many empirical studies
showing that herding exists over long periods of time in
various market-transaction time series; (2) DFA is the
only method we are aware of that breaks time series
down into segments and then (3) tests for PLs within the
segments (i.e., clear indications of long-tailed rank/fre-
quency distributions) as evidence of HB; (4) Breaking a
time series down into the shortest valid segments (i.e.,
they have to be long enough to include a valid rank/fre-
quency distribution) is the best way for identifying the
beginning of herding.
Results
Figure 3 shows the NASDAQs rise and fall between
January 4, 1993 and July 26, 2002, with the peak of the
market occurring on March 10, 2000. For identication
of the beginning of HB, we begin with analyses of various
segment lengths, starting at different points early on in
the NASDAQ time series (after January 4, 1993), which
are also shown in Figure 3. Our objective is to see if there
is a combination of segment length and starting date that
offers a clear, consistent indication of when HB begins.
Because we are looking at a bubble-build-up and crash
sequence that has already taken place from beginning to
end, and hence the crash point is well dened, we can
end some segments at the crash point and then take
them backward in time (see rows c, d, and h). While this
could only happen in real-time if all possible segment
lengths and starting times are continuously analyzed by
 168 M. J. M. TORRECILLAS ET AL.
a well-designed model (i.e., it could happen by chance),
in this study we are experimenting with just a few kinds
of segment lengths and starting-time congurations that
might offer meaningful H-based indications of the tran-
sition from EMB to HB.
1. Row a: The top line shows segments starting on
January 8, 1993 (the rst Friday). Each segment is
25 weeks long; hence HB indications come much
quicker. But their Hs are very inconsistent: some are
very high and some very low, and they more or less alter-
nate between high and low. While the segments appear
to give inconsistent indications of HB as on or off, they
do indicate that HB is either very strong or lying in
waitgiven various endogenous or exogenous cues, the
herd jumps on or off the bandwagon; this idea is more
consistently reinforced as the time series progresses.
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2. Rows b and c: These segments are approximately
one-year (50 weeks) long; row b starts on January 8,
1993. Row b segments alternate high and low early in the
sequence. But there are two high-H segments just before
and after the March 10 crash point, with an H D 0.54
segment in betweenthat is, strong HB buying before
the crash and then strong selling 25 weeks later, with
mixed buy-sell behavior from weeks 351 to 375 across
the crash date. Row c segments are the same length as
the row b segments but they start 25 weeks later. Note,
however, that just by starting 25 weeks later they show
four segments of H > 0.5 before the crash point, three of
which have Hs 0.65 or higher.
Viewing rows b and c together, we have the equivalent
of rolling segments (for previous use of rolling seg-
ments see Grech and Mazur [2004] and Alvarez-Ramirez
et al. [2008]). Each 50-week-long segment in one row
starts 25 weeks after a segment in the other row.
A couple segments in rows a and b give early indica-
tions that HB has been activated, but it is mostly lying in
wait till the time series gets to week 150, November 10,
1995, by which time eight segments in various rows have
shown H roughly 0.6 or higher. But only after week 175
do the 50-week segments show that HB is more consis-
tently evident. The presence of HB is re-conrmed in
various other follow-on segments that start on different
dates, as we discuss next.
To give a more graphic illustration of what underlies
the H values in row a compared with rows b and c, we
show close-up views of the price changes and Hs for
weeks 150, 251300, and 326375 in Figure 4. The 50-
week Hs and price changes (see rows a, b, and c in
Figure 3), respectively, are 0.59 (slight rise), 0.49 (up and
down), and 0.75 (steeply up). In weeks 1 to 25 in Figure 4
(row a) we rst see anti-persistenceH D 0.10small
price changes oscillate around the OLS line, but in weeks
26 to 50, we see a sharp upward OLS lineH D 0.67.
Across weeks 251300 (row b) we see H D 0.49, reect-
ing more random irregular up and down price move-
ments but in the rst half (250275) we see a slight move
toward persistence, and in the second half (276300) we
see a trend toward anti-persistenceH D 0.17. Finally,
in weeks 326375 (row c) we see both OLS trend lines
showing rising price changes, but again we rst see anti-
persistenceH D 0.02around what traders evidently
presume are rising fundamental values in dot.com rms,
but which then transform into persistent herd-driven
speculationH D 0.75reecting a steep rise in prices
just before the crash.
3. Rows d, e, and f: Segments in these rows are
75 weeks long; row d starts on January 8 and then the
segments roll forward in 25-week segments. What is
amazing to us is that during the dot.com bubble build-
up and crash, only two out of the total of 13 of these 75-
week segments ending at or before the crash show Hs
substantially above 0.5. Yes, one of these ends in late
November 1994, the time of the earliest grouping of H >
0.5 in the various rows, and the other ends 25 week later
in May 1996. Then there are no Hs > 0.5 in these seg-
ment-lengths during one of the most famous bubble
build-ups? This is our rst clear evidence that segment
length is critical.
4. Rows g, h, i, and j: These segments are 100 weeks
long. Row g also starts on January 8, 1993, but then each
row starts 25 weeks later. To begin, observe that the rst
segments in rows g & h show low Hs (i.e., 0.42 and 0.31),
but then as the rolling Hs in segments sequentially start-
ing 25 weeks later progress, we see Hs as follows: 0.76,
0.63, 0.76, 0.55, 0.66, 0.63, 0.57, 0.47, 0.60, and 0.70. All
but one H (D 0.47) are at or above 0.6 or round up to
0.6. This rolling series of segments rst indicates HB has
started at week 150 and then shows HB continuing past
the crash point except for the one segment of weeks
226325 showing H D 0.47it happens to include the
largest sell-off before the crash starting on March 10.
For reasons not obvious to us, row h shows only one
H not much above 0.50. In contrast, rows i and j show
all Hs at 0.6 or higher in all the segments ending before
the crash. Yet the segments are all of the same length
and are only 25 weeks different in start date. The start
date is critical.
Of all the rows, i and j are the most consistently indic-
ative of the start of HB and bubble-build-up. These seg-
ments start in 1994; they give consistent strong
indications of the presence of HB during the bubble
build-up before the crash date. But compare row h (only
one H > 0.5) with rows i and j. Also compare the 75-
week long segments d, e, and f with the 100-week seg-
ments in rows g, i, and j. The latter consistently show H
> 0.6 whereas rows d, e, and f show only two segments
 THE JOURNAL OF BEHAVIORAL FINANCE 169
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Figure 4. Shows enlarged views of price-change deviations above and below the OLS-t lines inside the DFA 25-week segments (row a)
for weeks 125, 251275, and 326350 on the left and segments for weeks 2650, 276300, and 351375 on the right. The dashed lines
show the OLS ts across both left and right segmentswhich show Hs D 0.59, 0.49, and 0.75 in rows b or c of Figure 3. Figure 4b shows
price changes above and below the OLS lines, which result in H D 0.49 for weeks 251300. The left-side segments of Figures 4a and 4c
depict anti-persistencelow Hs D 0.10 and 0.02 for weeks 127 and 326350. The right-side segments of Figures 4a and 4c depict per-
sistencehigh Hs D 0.67 and 0.81 for weeks 2650 and 351375.

with H D 0.60 & 0.75 (out of 13 before the crash). Even
though the segments are not all that different in length
75 versus 100 weeks longboth start dates and segment
lengths are critically important. Unfortunately, one can-
not know which is best until the time series has moved
past the closing dates of the segments.
5. Row k: The 150-week segments in this row also
start on January 8 and stay H > 0.5 through the 25-week
sell-off ending around September 25, 1998 (week 300).
Row k gives a strong and consistent indication of modest
HB in action, but the third segment drops to H D 0.44
while the market is moving dramatically both up and
down. Row ks time of earliest HB indication matches
that showing in row-i and also in rows a, b, and d. How-
ever, row k shows HB with some upward movement
early on in the market, but by the time the H of the third
segment is known, it is too late; it obscures the most dra-
matic up and down moves in the market.
One might think this is because H is high both before
and after the crash (i.e., Hs indicating strong herd buy
and sell behaviors), and the 150-week-long segment off-
sets the values of the two high Hs. But in row d the seg-
ment three weeks before the crash shows H D 0.51 and
the segment three weeks after the crash shows H D 0.45.
 170 M. J. M. TORRECILLAS ET AL.

HB does not appear to be present shortly before and after
the crash. Now look at row b. Here we see three 50-week
segments with Hs at 0.59 before the peak, 0.54 (across
the peak), and 0.59 soon after. Yet, for exactly the same
time seriesweeks 301 to 450segments in rows d and
k show Hs near or below 0.50. Again, segment length
makes a difference.
Table 1 offers a more obvious view of when the Hs
appear, when HB starts, and how they progress. Weeks,
dates, and changes in stock prices appear in the left-most
columns. Various Hs are shown, though we omit rows d, e,
and f. Looking at the bottom of the columns representing
rows a and b, we see quick and short indications of
Hs > 0.5. To the right and a bit higher in the table, arrows
highlight the rather obvious progression of Hs > 0.5 going
toward the upper-right. At the lower-left the Hs are on and
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could jump on board at this point. But H then stays
below 0.05 in these segment lengths for all of 1994.
2. With additional segment-start timings and seg-
ment-lengths, however, doubts emerge: Rows c
through k offer no indication of herding till
November 10, 1995.
3. If traders kept their H analyses going by using dif-
ferent segment start-times and segment-lengths,
they would eventually see that by November 10,
1995 (week 150), HB is present, as indicated by
segments in rows a, b, d, i, and k.
4. After 1995 we see a variety of H > 0.5 indications
popping up here and there in most of the rows,
though the 75-week segments show only two H >
0.5 before the crash.
5. Look at Figure 3 from week 251 to week 300. This

off, suggesting HB is on and off (analogous to the on/off
defensive or aggressive behavior of a buffalo herd), indicat-
ing that traders are uncertain about whether HB is really
worth the risk or not. But then, as the 100-week segments
go up toward the right, Table 1 indicates the transition
from EMB to consistently present HB. The arrows highlight
just how consistent HB is as the bubble develops. The dot-
ted-line arrow indicates when the crash occurs. This table
indicates how rational it would be for traders to apply
DFA along with continuous computational methods for
zeroing in on the shortest viable segment-length and start-
ing date for early detection of HB.
Boiled down, our DFA results are:21
1. By the end of 1993 (week 50), rows a and b give
early H-indications that HB is present. A trader
period shows price uncertaintyone strong buy-
segment and two strong sell-segments. Row a
shows Hs of 0.42 and 0.17 in this period; row b
shows 0.49 for the 251300-week segment. But
row b also shows H D 0.68 & H D 0.59 in the seg-
ments before and after this one. The H values go
random in this time period, the herd is uncertain;
but starting at week 300 the herd re-activates; the
bubble really takes off with various segments
showing higher Hs.
6. The most pronounced buy signals show up in
rows c, g, i, and j. In row c, we see high Hs in seg-
ments going from week 176 to week 375. In rows
g, i, and j the segments also show a continuous
buy signal from week 176.

Table 1. Dates are added to the weeks of the NASDAQ bubble shown in Figure 3. Price changes are shown along with the DFA seg-
ments. Arrows highlight the H values indicating the presence of HB. The beginning of HB appears in eight segments by week 150
(November 25, 1994). The dashed arrow indicates the time of the crash (March 10, 2000). In the segment-lengths shown in this table
(shaded), there is an indication of when the bubble starts and that HB continues consistently until the point of the crash. The presence
of H values at 0.6 or higher is most consistent in Rows i, j, and k, which show the 100-week segments.
Week Date Price Changes Row-a Row-b Row-c Row-g Row-h Row-i Row-j Row-k

500 26/7/02 65.93 0.5 0.4 0.5

475 1/2/01 44.23 0.4 0.4 0.5
450 10/8/01 306.04 0.2 0.6 0.6 0.4
425 16/2/00 1808.95 0.6 0.3 0.5
400 25/8/00 1005.94 1 0.5 0.5
375 3/3/99 2045.17 0.8 0.8 0.7
350 10/9/99 467.89 0 0.6 0.6
325 12/3/98 806.29 0.7 0.7 0.5
300 25/9/98 76.65 0.2 0.5 0.6 0.6
275 3/4/97 188.56 0.4 0.5 0.6
250 10/10/97 529.74 0.9 0.7 0.7
225 18/4/96 0.79 0.4 0.7 0.6
200 25/10/96 19.84 0.8 0.5 0.8
175 3/5/95 139.57 0.2 0.5 0.6
150 10/11/95 192 0.7 0.9 0.8 0.6
125 19/5/94 119.55 0.9 0.5 0.3
100 25/11/94 8.27 0.4 0.5 0.4
75 3/6/93 16.85 0.4 0.4
50 10/12/93 65.93 0.7 0.6
25 18/6/92 12.24 0.1

7. BUT, by the time the Hs indicate sell the market
has lost 3,000 points. Around the crash point, the
Hs either indicate H at roughly 0.5 (dened as ran-
domness by the econophysicists), or, as in rows a
and b, indicate consistent HB, but not that the
herd switches from herd-buying to herd-selling.
8. Is there an indication about when to sell? Six of the
11 rows show HB pretty much disappearing right
before and after the crash point. Note, however,
that there are also Hs > 0.5 as HB appears when
more and more traders start selling. Our DFA
analysis does not give a strong indication for stay-
ing in long enough to take advantage of the steep
rise after September 1999 (week 350), nor when to
bail.
9. Note that the last segment in row k shows H D
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0.44 from 75 weeks before the crash to 75 weeks
after. Why? Is it a combination of a herds strong
buy and then strong sell decisions, both within
the same segment? Now look at row d for the
same time period. Here we see that H is 0.51 three
weeks before the crash and 0.45 for the three weeks
after. But in contrast, rows a, b, e, and i show H
0.6 after the crash. Depending on segment-length
and start dates of the segment sequences, H
appears to show, or not to show, the existence of
HB before and after the crash.
10. Our DFA analysis does offer various indications of
the beginning of the dot.com bubble and continu-
ing HB, but DFA does not offer any clear predic-
tion of when the Crash starts.
The 25-week segments detailed in Figure 1 show
Hs of 0.69, 0.02, & 0.81 just before the crash and
0.97, 0.64, and 0.21 just after. Figure 5 details H val-
ues in longer segments just before and after the crash
point. The 50-week segments just before and after the
Figure 5. Shows the OLS t R2s and H exponent values for the weeks before, during, and after the crash starting the week after March
10, 2000. The 100-week segments show a consistent H > 0.5 leading up to the crash. The three segments extending before and after
the crash show H values near 0.5which econophysicists dene as random white noise. But in this Figure the H near 0.5 is obviously
a combination of strong herd buying and selling (see also the 25-week segment Hs in Figure 1). DFA H values do not offer any obvious
indications of the impending crash.
THE JOURNAL OF BEHAVIORAL FINANCE 171
crash show H D 0.81 & 0.33. The 50-week segments
with end dates at weeks 350 and 450 both show
Hs D 0.59. The 100-week segment starting 50 weeks
before and ending 50 weeks after the crash shows
H D 0.49. The 150-week segment from weeks 300 to
450 shows H D 0.44. The Hs for the foregoing differ-
ent segment-lengths and starting dates offer no useful
information that a major crash is about to occur. As
seen in Figure 1, the herd temporarily returns to
anti-persistent behavior during periods of investor
uncertaintyweeks 326350but then regains its
herd mentality, as we see happening as traders go
from week 351 through the three following segments
to week 425 (see Figure 1). Note that in the 376400-
week segment we see the herd making wild buy/sell
moves that produce a very low R2 but a very high H
during this period of uncertainty after the crashthe
herd still stays connected but cannot decide whether
to keep buying or start sellingso it does both as a
herd.
Some readers will wonder why we use weekly price
uctuations instead of daily uctuations. In Table 2
we show some comparative analyses of the more
extreme H values to see if differences appear and are
worth taking into account. As our sampling of weekly
versus daily closing prices indicates, the Hs are
mostly less extreme for daily price uctuations than
for weeklies. If the herd is uncertain and is bouncing
back and forth between buying and selling, the OLS
deviations more or less offset each other, thereby
bringing weekly H values away from really high or
low indications of HB. Alternatively, if the herd gen-
erally leans toward only buying (or only selling) on
the ve week days, the weekly closing price would
show a more dramatic deviation away from the H D
0.5 value. Given these comparative results, we believe
 172 M. J. M. TORRECILLAS ET AL.

Table 2. Shows the difference in H values for daily versus weekly closing prices in the NASDAQ Index for selected segment lengths pre-
sented in Figure 3. The upper table consists of only segments in Row a. The lower table shows differences in daily vs. weekly H values
for some of the segments in rows h, i, and k. Note, that the Hs for weekly prices are mostly further away from H D 0.5 than the dailies;
and that the only substantial conicting difference appears in the shaded segment.
Segments in Row a.
Segments in Row a.

Weekly H D 0.67 H D 0.93 H D 0.66 H D 0.69 H D 0.80 H D 0.39 H D 0.92 H D 0.02 H D 0.97
Daily H D 0.50 H D 0.68 H D 0.55 H D 0.70 H D 0.60 H D 0.50 H D 0.70 H D 0.20 H D 0.37

Segments in Rows i, j, and k.

Weekly: Row h: H D 0.31 Row i: H D 0.76 Row k: H D 0.57

Daily: Row h: H D 0.42 Row i: H D 0.62 Row k: H D 0.60

our choice to use only weekly prices in Figure 3 is to have multiple price-changes over time for the PL dis-
validated. tribution to materialize. Until this occurs, it is impossible
However, in the last segment in the row a section of to know what level H is at by using the DFA method.
Downloaded by [University of Nebraska, Lincoln] at 09:02 28 May 2016

Table 2, H shows a dramatic shift from the weekly H D

0.97 to the daily H D 0.37 (i.e., from persistence to anti-
persistence). Switching from weeklies to dailies shifts the
H from indicating a strong presence of HB to minimal
presence. We included the 25-week segments because,
obviously, traders would like to get the earliest indication
of HB as possible. However, they are more questionable
in their results. As much as traders might like really early
indications of HB presence, the 25-week segments may
be suspect in the quality of information they provide.
In summary, there are two H-clues that HB has
started sometime in 1993, but the earliest this is known
is the end of 1994. The earliest corroborated evidence of
a bubble build-upbased on ve segments showing H 
0.57appears in November 1995. Because of the seg-
ment length requirement, it does take some passage of
time before HB can be indicated simply because we have
Comparison to recent alternative big data
methods
Preis, Reith, and Stanley [2010] draw insights from
search engine query data (p. 1). Balcilar et al. [2012]
specically conclude that global shocks signicantly
contribute to investor herding (p. 1). Bordino et al.
[2012] nd that web search queries can predict stock
market volumes (p. 1). Moat et al. [2013] nd that loss
averse individuals are more apt to rely on Wikipedia
searches to anticipate falls in stock-market prices. Preis,
Moat, and Stanleys [2013] use of Google searches to see
whether big data style information offers advance indi-
cations of dramatic stock-market changes. In Figure 6
we show Preis et al.s comparison of the dramatic rise in

Figure 6. Shows Figure 1 from Preis et al. [2013], which is positioned above their gure 2. The dashed line shows the 2009 dates of both
gures line up. In Figure 2 we see that debt based on Google searches starts rising before the post-crash rise in the DJIA starts, hence
offering some predictive value to traders. But it also shows that the debt indicator rise (dark grey; in blue online) pretty much at-lines
after 2010, even though the DJIA keeps rising.

the DJIA after the collapse of stock markets2008 to
2009 (upper graph)with an increase in Google searches
using the search-term debt (lower graph). It is obvious
that there is a steep increase in Google searches before
the DJIA hits the bottom and starts back up. Thus the
Google search data offer uptick information before the
uptick begins. In contrast, however, the Google search
graph more or less at-lines after 2010the Google-
search data tell us that the DJIA will stay around
10,000even though the DJIA keeps rising.
The key difference between Preis et al.s method and
our use of DFA is that they draw from a database outside
of the stock market, whereas we apply DFA directly to
stock trader buy/sell decisions to nd evidence of herd-
ing embedded explicitly in stock buy/sell decisions. The
methods are obviously different, but more research is
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needed before one can decide which one is a more useful
and reliable predictor. Their method gives a strong indi-
cation of the forthcoming start of the bubble some four
months in advance. Our use of DFA (see rows i and j in
Figure 3) offers information that herding is developing
150 weeks and more, before the sharp upturn begins.
One possibility is that big data searches cause HB,
which then causes bubbles.
Conclusion
Our review of the herding literature in nance shows no
evidence that any empirical method has been applied to
directly identify the beginning of herding behavior (HB)
in stock markets and thereby the transition from efcient
markets (EM) to HB. Our review also shows that HB has
just barely seeped into Physica A; Yook and Kim [2008]
and Kukacka and Barunik [2013], with no application of
DFA to study HB, have not attempted to identify the
transition from efcient markets behavior (EMB) to HB.
However, HB studies appear more frequently in interna-
tional studies, such as Venezia, Nashikkar, and Shapira
[2011], Al-Shboul [2012], Shih et al. [2012], Bhaduri and
Mahapatra [2013], Garg [2013], Gebka and Wohar
[2013], Lin, Tsai, and Lung [2013], Bohl, Klein, and
Siklos [2014], Demirer, Kutan, and Zhang [2014],
Sarpong and Sibanda [2014], and Yao, Ma, and He
[2014]. Starting down a new path, we use detrended
uctuation analysis (DFA)the preferred method from
econophysics to identify nonrandom movements in time
series of various kindsto attempt to identify the transi-
tion from EMB to HB and the bubble build-up in the
NASDAQ Composite Index from January 4, 1993 to July
26, 2002 (which also includes the crash starting on
March 10, 2000). DFA reduces a time series into a series
of time-series segments, which, if one follows what
Peng et al. [1995] do, are then subdivided several times
THE JOURNAL OF BEHAVIORAL FINANCE 173
sequentially by 2 down to the shortest time series chosen.
In our case this consists of a series of experiments of ini-
tial segment lengths ranging from 150 weeks down to
25 weeks (the latter are further binary subdivided to seg-
ment-lengths of 3 weeks).
We cite many studies showing (1) that long-tailed
Pareto and power-law (PL) distributions are associated
with the appearance of nonlinear changes in stock prices,
and (2) the links among nodes in social and business net-
works often appear Pareto and PL distributed. These
studies suggest using DFA to connect the rise or fall of
HBr with changes in stock prices. DFA calculates a
within each segment; the higher is a the more dramatic
is the PL distribution of stock prices with the segment.
The slope of the a plot line in a graph sets up an estimate
of what econophysicists call H, the Hurst Exponent,
which we use as a measure of HB intensity.
Our results offer mixed signals: (1) Different segment
lengths and starting dates produce varying indications of
strong or weak HB, as shown in Figure 3 and Table 1. (2)
The shortest segments periodically offer the strongest H
values, but are also the most inconsistent. (3) Our earliest
consistent HB indication (coinciding with the visual indi-
cation of the beginning of the bubble build-up; that is,
the rise in the stock chart starting in early June 1994
[week 75]) appears in segments ending on November 10,
1995 (week 150). (4) This is the date when 5 HB signals
(i.e., Hs > 0.6) at the ends of segments of varying lengths
all coincide to offer the strongest indication of HB pres-
ence. (5) This high HB indication stays most consistently
at H > 0.6 in the rolling series of 100-week long seg-
ments starting at the end of 1993 (week 50) and rolling
forward (in 25-week jumps) until one of them ends on
the date of the crash (March 10, 2000). (6) As an indica-
tion of the importance of choosing the best segment
length, the rolling series of 75-week long segments shows
only two H  0.6 out of a total of 13 before the crash.
Finally, (7) DFA does not offer an obvious prediction of
the NASDAQ crash.
Several qualications need mentioning. Our data
source is the NASDAQ leading up to the dot.com crash.
We explicitly use NASDAQ for testing whether DFA is a
valid method for identifying HB (or not) because it is
not a fully random mix of stocks; it is not representative
of the indices designed to consist of a random mix of
stocks. While DFA is currently most popular among
econophysicists, there are various other methods yet to
be explicitly tested as indicators of the EMB-to-HB tran-
sition, for example, R/S analysis (Hurst [1951], Hurst,
Black, and Sinaika [1965]), power spectral density
(Heneghan and McDarby [2000]), ARFIMA estimation
(Sowell [1992]), wavelets (Muzy et al. [1994], Gencay,
Selcuk, and Whitcher [2002]; Yalamova [2003]), log
 174 M. J. M. TORRECILLAS ET AL.
periodicity (Johansen and Sornette [1999], Sornette and
Johansen [2001]), generalized Hurst exponent (Di Mat-
teo [2007]), and most recently a geometric method (Tri-
nidad, Fern
andez, and S
anchez [2012]) or the cross-
sectional standard versus absolute deviation (Chen
[2013]). Most of the former have been used to identify
multifractality in stock markets and/or attempt predic-
tions of crash points rather than the starting points of
bubble build-ups. At this point we favor weekly uctua-
tions because they produce more differentiated H values,
but daily uctuations may offer improved accuracy in
very short segments.
There are several kinds of follow-on research to be
pursued. First, we have used DFA, which essentially
looks for PL-distributed uctuations in the data to make
the H estimate. But PL methods may be used without
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using the H exponent. We believe PLs (i.e., H > 0.6)
offer the best indication of the EMB-to-HB transition;
however, DFA and other methods (several listed just
above), need to be empirically compared to see which
one is the best indicator of HB. There is no research to
date that explicitly compares the various methods men-
tioned just above as to how well they identify the EMB-
to-HB transition in a well-known bubble-build-up. Sec-
ond, DFA offers on-off indications of HB (i.e., high Hs
in some segments but not others) in what is recognized
as a very obvious bubble build-up; DFA may turn out to
be useless in less pronounced bubble situations. But of
course, there are always sub-bubbles waiting to be identi-
ed in any stock market, as indicated by the various mul-
tifractal price-change ndings.22 Third, the most obvious
means of further testing DFAs and other methods abil-
ity to indicate the start of HB is to focus on even less ran-
domly composed indices than NASDAQ. HB would be
more likely to occur in these indices. Finally, one could
also move the foregoing research to an articial com-
puter-based stock market where one could rst create
HB-based stock buying and then test how well DFA or
other methods identify the EM-to-HB transition; Lamba
and Seaman [2008] offer the rst study starting down
this path.
We have not found an obvious solution to the
dilemma; that is, the shorter the segment (which is
good for early indications by traders) the more unreliable
the H indication. Buying and selling in stock markets,
however, is more about when to take how-much risk
rather than statistically signicant scientic-truth nd-
ing. Traders presumably would not choose to wait until
scientic proof indicates that HB has seeped into a
stock index. But H values become more and more ques-
tionable as the smallest subsegment length is shortened.
In our row a, for example, the H values mostly alternate
high and low from one segment to the next. Is this about
a poor method or rather that HB frequently strengthens
now and then but also goes back to a lying in wait state,
such as herding versus random behaviors in buffalo
herds? Further results also lie in wait.
What does H D 0.5 really mean? We see: (1) a very
low H D 0.02 segment (in row a) indicating anti-persis-
tence in volatility; frequent reversals; (2) an H D 0.97
segment (in row a) that includes both strong herd selling
and buying behaviors, that is, high persistence in volatil-
ity; and (3) an H D 0.49 segment (in row h from weeks
326425) that includes dramatic before crash HB buy-
ing and dramatic after crash HB selling, and the H D
0.44 segment in the row j (weeks 301450). Yet econo-
physicists dene H D 0.5 as indicating only white noise
or Brownian motion, that is, random buying and sell-
ing. In stock market time series, H equals roughly 0.5
cannot be assumed to only indicate random Brownian
motion. In Figure 5, we see obvious indications that per-
sistent within-segment HB-caused buying and then sell-
ing (i.e., high Hs before and after the crash) can produce
H 0.5 when combined within one segment.
Our H and HB ndings reduce to four critical points:
1. For nance: DFA and the H exponent do show that
emergent HB is demonstrably associated with the
transition from EMB to HB. Only after segments
consistently showing H > 0.6 do we see a consis-
tent and more dramatic rise in the NASDAQ
index.
2. For econophysics: DFA analysis and H > 0.6 indi-
cations are at the mercy of segment lengths and
starting dates. There is also some likelihood that
multifractality within a segment could show H is
roughly 0.5 rather than consistent persistence
because persistence could be created by periods of
consistent buying and consistent selling within the
same segment. Strong HB in different directions
(up or down) can easily produce an H is 0.5 when
in fact random Brownian motion is nowhere in
sight.
3. For both: A: Given (a) sequences in buying or sell-
ing; (b) PLs as indicators of H; (c) that the presence
of H > 0.6 indicates HB; and (d) that our ndings
show HB producing up and down sequences
within single segments, there is an empirical basis
for using H > 0.6 to indicate HB and consequently
persistence in rising or falling prices (and underly-
ing volatility). B: Though DFA appears to be a use-
ful method for estimating H and hence identifying
HB, segment lengths and their starting dates are
critical, however. Given the results shown in
Figure 3, what appears to be needed is a computer
model that is able to constantly change and calcu-
late Hs for the full range of segment lengths and

starting dates pertaining to an ongoing nancial
time series so as to identify persistent user behav-
iors, that is, H  0.6 and evidence of herding.
4. The DFA method is not able to indicate whether
HB is persistently aimed at buying or selling. The
various segments in Figure 3 show that H > 0.6
can indicate upward, or downward, or both up and
down price movements within a single segment.
Consequently, we have reason to question whether
DFA and related methods that depend on the reli-
ability of H for being able to indicate persistent
rises or falls in stock prices based on PL indicated
behaviors are valid methods for anticipating crash
points. Therefore, based on our analysis of one of
the all-time dramatic and obvious bubble-build-
ups and crashesNASDAQ: 19932002there is
Downloaded by [University of Nebraska, Lincoln] at 09:02 28 May 2016
some reason to be skeptical about the use of DFA
and H to predict an impending crash.
Notes
1. Others include Froot, Scharfstein, and Stein [1992], Tru-
man [1994], Christie and Huang [1995], Grinblatt, Tit-
man, and Wermers [1995], Devenow and Welch [1996],
Avery and Zemsky [1998], among others.
2. For example, Chang, Cheng, and Khorana [2000], Cont
and Bouchaud [2000], Shiller [2000, 2002], Shleifer
[2000], Welch [2000], Bikhchandani and Sharma [2001],
Brunnermeier [2001], Hirshleifer and Teoh [2003], Parker
and Prechter [2005], Bernhardt, Campello, and Kutsoati
[2006], Clarke and Subramanian [2006], Hirshleifer, Sub-
rahmanyam, and Titman [2006], Rook [2006].
3. For example, Gopikrishnan et al. [1999], Muzy et al.
[2001], Mandelbrot and Hudson [2004], Gabaix et al.
[2007], Lux [2004], Stanley, Plerou, and Gabaix [2008],
Zunino et al. [2009], Mandelbrot [2010], Barunik et al.
[2012], Yuan, Zhuang, and Liu [2012], Wang, Ziang, and
Pandey [2012], Pav
on-Dom
nguez [2013], Siokis [2013],
Sensoy [2013], Wang and Xie [2013], Su
arez-Garcia and
G
omez-Ullate [2014].
4. See Barab
asi [2002], Battiston and Catanzaro [2004], Gay
and Dousset [2005], Souma et al. [2006], Chmiel et al.
[2007], Santiago and Benito [2008], Gerow and Keane
[2011], Hu et al. [2013], Mizuno, Souma, and Watanabe
[2014].
5. For example, Gopikrishnan et al. [1999], Lo and MacKin-
lay [1999], Sornette [2003], Jondeau, Poon, and Rockinger
[2007], Stanley, Plerou, and Gabaix [2008], Jiang et al.
[2010], Alvarez-Ramirez et al. [2012], Reboredo et al.
[2013].
6. The Economist especially emphasizes its and others con-
cerns about value at risk, correlated trading behaviors and
price movements, as well as positive feedback in its 18
page Special Report on Financial Risk (February 13, 2010,
inserted between pp. 52 and 53).
7. More recently, the works of Schroeder [1991], Peters
[1994], West and Deering [1995], Lo and MacKinlay
[1999], Mantegna and Stanley [2000], Bouchaud and
THE JOURNAL OF BEHAVIORAL FINANCE 175
Potters [2000], Sornette [2003], Malevergne and Sornette
[2005], Jondeau et al. [2007], Calvet and Fisher [2008],
Gabaix [2009], Yuan, Zhuang, and Xiu [2009], Mandel-
brot [2010], Barunik et al. [2012], Kristoufek and Vosvrda
[2013], Schinckus [2013], Siokis [2013].
8. See also Newman [2005], Newman, Barab
asi, and Watts
[2006], Chou and Keane [2009], and Glaser [2012].
McKelvey and Salmador [2011] list another 60 or so spe-
cically in nancial economics.
9. Self-organized criticality characterizes a system if it is able
to self-organize itself so as to maintain its viability in the
context of constantly changing internal or external condi-
tions. PL distributions usually dene such systems.
10. Correlation between power law and straight line is 0.984.
Data are Dow Jones stock market prices in 1960. Firms
include AT&T Inc., General Motors Company, Interna-
tional Business Machines Corporation, Standard Oil, E. I.
du Pont de Nemours and Company, and General Electric
Company.
11. See Goldfarb, Kirsch, and Miller [2007], Dyer et al. [2008],
Tan et al. [2008], Yook and Kim [2008], Hott [2009], Bad-
deley [2010], Jeon and Moffett [2010], Blasco, Corredor,
and Ferreruela [2011], Alvarez et al. [2012], Prosad,
Kapoor, and Sengupta [2012], Rejichi and Aloui [2012],
Saumitra and Sidharth [2012], Gao et al. [2013], Laih and
Liau [2013], Kristoufek and Vosvrda [2013], Ouarda, El
Bouri, & Bernard [2013], Reboredo et al. [2013], Sensoy
[2013].
12. Multifractal means that the visual chart depictions of
many small, to fewer large, to a single very large
stock-market price movement looks more or less the
same (i.e., self-similar) at multiple points as a time
series progresses because of on-&-off herd behaviors.
Multiscaling refers to the likelihood that herding can
be stronger or weaker, thereby changing the steepness
of a specic price change progression and/or how long
it continues.
13. See also Muzy et al. [2001], Lux and Ausloos [2002],
Matia, Ashkenazy, and Stanley [2003], Borland et al.
[2005], Calvet and Fisher [2008], Du and Ning [2008],
Barunik et al. [2012], Yuan, Zhuang, and Liu [2012], Sio-
kis [2013], Wang and Xie [2013].
14. Such as Michalski [2008], S
anchez, Trinidad, and Garc
a
[2008], Cajueiro, Tabak, and Werneck [2009], Yan,
Woodard, and Sornette [2010], Barunik and Kristoufek
[2011], S
anchez, Fern
andez, and Trinidad [2012], to name
a few.
15. Observers could say that the bubble began with the begin-
ning of NASDAQ. We pick January 4, 2015, starting date
because the index stayed relatively at for the year of
1992, gaining only 84 points.
16. See also Hu et al. [2001], Chen et al. [2002], Matia, Ashke-
nazy, and Stanley [2003], Grech and Mazur [2004], Matos
et al. [2007], Alvarez-Ramirez et al. [2008], Serletis, Urit-
skaya, and Uritsky [2008], Wang, Wei, and Wu [2011],
Yuan, Zhuang, and Liu [2012], Chen [2013], Pav
on et al.
[2013], Kristoufek and Vosvrda [2013], Reboredo et al.
[2013], Sensoy [2013], Su
arez-Garcia and G
omez-Ullate
[2014], among others.
17. For Peng et al.: Rank goes from the smallest to the one
largest segment out at the end of the X-axis. Frequency
goes from the average uctuation within the smallest
 176 M. J. M. TORRECILLAS ET AL.
segments nearest to the origin up to the average uctua-
tions within the single largest segment up at the end of the
Y-axis.
18. The program we used to calculate DFAs and the H expo-
nents and create the PL graphs was coded up in MATLAB
by Max Little et al. [2006].
19. It is an estimate because econophysicists assume that the
angle of the a slope of the PL line in a graph equates to the
H exponent.
20. Though we mention positive-feedback here because it is
more dominant in recent analyses (e.g., Hott [2009], Jeon
and Moffett [2010]), we also note that preferential attach-
ment (the more one node attracts, the more attractive it
becomes, for example, hub and spoke airports, rich get
richer, well-known authors attract other would-be coau-
thors, etc.) also explains herd behavior and other scale-
free causes may apply as well (for denitions of various
other scale-free causes, see Andriani and McKelvey
[2009]).
Downloaded by [University of Nebraska, Lincoln] at 09:02 28 May 2016
21. Remember, one does not know what H is until a segment
ends.
22. In studies such as Muzy et al. [2001], Matia, Ashkenazy,
and Stanley [2003], Borland et al. [2005], Calvet and
Fisher [2008], Yuan, Zhuang, and Xiu [2009], Yuan,
Zhuang, and Liu [2012], Barunik et al. [2012].
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