Johannesburg — THE stock market has its share of shake-ups, but who would guess that large movements in this man-made system adhere to a similar pattern of predictability as earthquake magnitudes? Researchers at Boston University and the Massachusetts Institute of Technology have found that stock prices follow a distribution that is almost identical to that of earthquakes. "Financial earthquakes and natural earthquakes are perfect analogues for one another," says Dr Eugene Stanley, director of the Centre for Polymer Studies at Boston University, who performed the research with Dr Xavier Gabaix, a professor of economics at MIT.

While some have suspected for years that stock market fluctuations follow a power law, the new research shows that stock indices in Hong Kong, Tokyo and Europe all follow the same law.

The patterns found by the scientists are "power laws" that describe mathematical relationships between the frequency of large and small events. One such power law is used to forecast the chances that an earthquake of a given magnitude will occur.

In short, the scientists have shown that stock markets have a mathematical elegance frequently found in natural systems.

As Gabaix explains: "We have found that the artificial world of the financial markets follows a pattern similar to one found in our natural world. Trading on the stock market has a lot of randomness but at the end of the day you find that a pattern emerges that matches power law patterns found empirically in data from systems as diverse as earthquakes and human language."

The team also found that the actions of large market participants, such as mutual funds, produce this power law behaviour when they trade stock under time pressure.

"We want to understand financial earthquakes in order to protect people like you and me, whose retirement is tied up in the markets," says Stanley. "In Tokyo they build buildings so that they don't succumb to earthquakes. We need to do the same thing in economics.

"But our research suggests that the forces that give rise to the power laws of stock market fluctuations are extremely robust," says Gabaix. "So unfortunately, such crashes would be very, very hard to prevent.

"When applied to a precise computer model, the power laws might allow market analysts to predict a crash, but not necessarily prevent it.

"We believe that the computer model presently used by most analysts undercounts the number of large, rare events. That is what we're looking at next," says Gabaix.

"If we combine physics methods and economic reasoning, we may be on the right track."