Capturing long-tailed black swan risk in east asian currencies

• Main Authors: Andrews, S., Kwek, K.T, Cho, C.W.
• Format: Conference or Workshop Item
• Language: English
• Published: 2010
• Subjects: HB Economic Theory
• Online Access: http://eprints.um.edu.my/11308/1/CS4-G1_Kwek.pdf; http://eprints.um.edu.my/11308/

The Global Financial Crisis of 2008 and the Asian Financial Crisis of 1997/1998 are two events that share a common characteristic. Both can be seen as a network crisis, though one is global and the other is regional. The world or region is currently highly inter-connected and inter-dependent through trade, finance and telecommunication networks that transfer information and property rights that shape behaviour across networks. This can be illustrated through behaviour in highly complex and deep financial markets, such as behaviour in currency markets arising from contagion and inter-action between market forces that create unexpected risks. This paper introduces a Phasor method to capture the often ignored long-tailed black swan risk, also known as rare events. Using the augmented network theory (Sheng, Kwek, Cho, 2009), based on principles of engineering and physics, we model the market movements caused by the confluence of different market forces, by transforming the market movements (x,y) into sinusoidal waves (cosθ, sinθ). In particular, when the two forces collide (cosθ = sinθ), they create directions that are not always predictable, though the amplitude of the sine waves and the cosine waves are predictable. To demonstrate this network effect, nine currencies, i.e. the Indonesian Rupiah, Chinese Renminbi, Hong Kong dollar, Korean Won, Japanese Yen, Malaysian Ringgit, Philippines Peso, Singapore dollar, and Thai Baht are modeled through the Phasor theory in the currency markets. The results of the study do show that we are able to capture these rare events. While not all directional changes are predictable due to lack of contextual information that we may not be able to capture, there are certain patterns of behaviour that conform with tools common in engineering and physics.