Chaos Theory and the Financial Markets

Connelly, Thomas J.
December 1996
Journal of Financial Planning;Dec1996, Vol. 9 Issue 6, p26
Academic Journal
Chaotic time series often display non-periodic cycles and trend-reinforcing behavior. In other words, one may discern cyclical patterns from afar, but one can't predict when they will begin. when they will end or how severe they will be. There are three reasons for the strange and largely unpredictable behavior of chaotic systems. First, chaotic systems are feedback systems where outputs from a previous period are the inputs for the next period. Second. seemingly insignificant inputs may be compounded over and greatly influence the behavior of the system. A third feature of a chaotic system is sensitive dependence on initial conditions. Thus, in a chaotic system, knowledge of the relationships between variables,seemingly insignificant variables, and the initial conditions of the system are critical for modeling its behavior. In this type of system determination and prediction of cause and effect can be perilous. Chaotic systems are unpredictable. Even though they may be of limited directly, they add value by enabling one to view nature and some social systems from a different, and perhaps more realistic perspective.


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