Endogenous versus Exogenous Origins of Crises

by Didier Sornette

SHORT SUMMARY:
Analysis of precursory and aftershock properties of shocks and ruptures in finance, material rupture, earthquakes, amazon.com sales, etc: we find ubiquitous power laws similar to the Omori law in seismology that allow us to distinguish between external shocks and endogenous self-organization.

LONG SUMMARY:
Self-organized criticality, and more generally, complex system theory contend that out-of-equilibrium slowly driven systems with threshold dynamics relax through a hierarchy of avalanches of all sizes. Accordingly, extreme events are seen to be endogenous, in contrast with previous prevailing views. But, how can one assert with 100% confidence that a given extreme event is really due to an endogenous self-organization of the system, rather than to the response to an external shock? Most natural and social systems are indeed continuously subjected to external stimulations, noises, shocks, sollications, forcing, which can widely vary in amplitude. It is thus not clear a priori if a given large event is due to a strong exogenous shock, to the internal dynamics of the system, or maybe to a combination of both. Adressing this question is fundamental for understanding the relative importance of self-organization versus external forcing in complex systems.

This question, whether distinguishing properties characterize endogenous versus exogenous shocks, permeates many systems, for instance, biological extinctions such as the Cretaceous/Tertiary KT boundary (meteorite versus extreme volcanic activity versus self-organized critical extinction cascades), commercial successes (progressive reputation cascade versus the result of a well orchestrated advertisement), immune system deficiencies (external viral/bacterial infections versus internal cascades of regulatory breakdowns), the aviation industry recession (9/11 versus structural endogenous problems), discoveries (serendipity versus the outcome of slow endogenous maturation processes), cognition and brain learning processes (role of external inputs versus internal self-organization and reinforcements) and recovery after wars (internally generated (civil wars) versus imported from the outside) and so on. In economics, endogeneity versus exogeneity has been hotly debated for decades. A prominent example is the theory of Schumpeter on the importance of technological discontinuities in economic history. Schumpeter argued that ``evolution is lopsided, discontinuous, disharmonious by nature... studded with violent outbursts and catastrophes... more like a series of explosions than a gentle, though incessant, transformation''. Endogeneity versus exogeneity is also paramount in economic growth theory. Our analysis suggests a subtle interplay between exogenous and endogenous shocks which casts a new light on this debate.

We study the precursory and recovery signatures accompanying shocks in complex networks, that we have tested on a unique database of the Amazon sales ranking of books and on time series of financial volatility. We find clear distinguishing signatures classifying two types of sales peaks. Exogenous peaks occur abruptly and are followed by a power law relaxation, while endogenous sales peaks occur after a progressively accelerating power law growth followed by an approximately symmetrical power law relaxation which is slower than for exogenous peaks. These results are rationalized quantitatively by a simple model of epidemic propagation of interactions with long memory within a network of acquaintances in the case of the Amazon data and by the ``multifractal random walk'' model in the case of the financial volatility time series. The slow relaxation of sales implies that the sales dynamics is dominated by cascades rather than by the direct effects of news or advertisements, indicating that the social network is close to critical.

Please see related articles at http://www.ess.ucla.edu/faculty/sornette/essay_endogenous.asp#endogenous