Investigating Stock Market Crashes Using Cusp Model: A Study on Tehran Stock Exchange

Abstract

Stock market crashes are important, both for investors and academics. Since Catastrophe Theory is a strong tool for explaining nonlinear phenomena, in this paper we apply Catastrophe theory and fit stochastic Cusp Catastrophe model to Tehran Stock Exchange (TSE) data. With the help of annual growth rate of liquidity and stock trading volume as control variables, we show that the Cusp catastrophe model explains the crashes of the TSE index in 2004 and 2008, much better than non-linear logistic model. Our results are confirmed after removing trend from Tehran Stock Exchange price index.

Keywords

• stock market crashes
• catastrophe theory
• stochastic cusp catastrophe model
• bimodal distributions