The document summarizes China's 2015 stock market bubble and bust in four phases: 1) Exponential rise and positive outliers marked the initial bubble phase. 2) Increased volatility and negative outliers marked the topping process. 3) Negative outliers clustered and markets entered a downward spiral in the bust phase. 4) Risk contagion spread to other asset classes from Chinese stocks.

1. HeavyTails 2015 China Bubble Early Warning Case Study
Alan Laubsch
23 September 2015
China’s 2015 bubble bust following a classic four phases process of emerging systemic risk.
Phase 1: Bubble with exponential rise, positive outliers and momentum
Phase 2: Topping marked by negative outliers and increasing volatility
Phase 3: Bust marked by negative outlier clustering and imbalance, and downward spiral
Phase 4: Contagion to other asset classes
We well use the most liquid US listed China ETF $FXI to illustrate this process of systemic risk
escalation.
From Phase 1 to 2
The final stage of Phase 1 was marked by a positive outlier cluster and escalating volatility
between 30 March and 10 April.
Then on 17 April Chinese equities plunged by 2σ. This marked the beginning of a topping
sequence, which is characterized by increased volatility and downside outlier clustering as more
market participants become aware of a new disruptive investment theme (see Adaptive Risk
Management, Laubsch 2015)
Fig 1. HeavyTails view of 17 April 2015 China equity outlier

2. Phase 3: Bear Transition
Markets continued to trade sideways, increasingly tilting from positive to negative outlier
imbalance (we monitor 20 and 100 day views)
FXI’s 26 June negative outlier marked a critical point, as increased negative outlier clustering
becomes obvious. We also start to observe contagion across Asia (in this case Southeast Asia
and Australia).
Fig. 2. 26 Jun 2015 China outlier snapshot and VaR backtesting graph
1. Exp.
rise
2.
Topping
process
3.
Negative
spiral
Contagion

3. Stage 4: Contagion
The 29 June outlier marked broader systemic risk contagion, with a classic flight to safety. S&P
500 and other equity indices dropped by over 2.8σ. Systematic risk jumps from 100 day lows as
markets begin to couple (e.g., length of tree shrinks).
Fig. 3. 29 June HeavyTails snapshot highlighting network metrics

4. Led my a plunge in oil, commodities, and emerging markets, Chinese equities continue a
downward spiral on 6 July.
Instead of occupying the periphery with low correlation to other assets, China moves closer to
the center of the network, as seen in Fig 4.
Fig. 4. Systemic Risk Spiral on 6 July 2015 with China in the middle

5. China becomes closely coupled to Emerging Markets ($EEM) and correlation to other assets
increases broadly.
Fig 5. China HeavyTails correlation focus map and Emerging Markets coupling

6. Summary
China’s 3 stage Bubble to Bust sequence is summarized in the 100 day chart below.
Fig. 5. HeavyTails chart shows China’s rapid boom to bust phase transition
Conclusions
Chine’s stock’s exponential rise, even as economic growth started faltering, is yet another
classic equity bubble case study. Outlier risk signals focus our attention important changes in
social sentiment which can result in major phase transitions. While these signals were
exceptionally clear for Chinese equities, they are often more ambiguous and require social
intelligence to interpret. Outlier based risk discussions are a key risk practice, and network
visualization should be viewed as an intelligence amplification platform for social intelligence. It
focuses everyone’s attention on the same ball, and enables intuitive communication about
emerging risk.