Joseph Effect

A measure that indicates whether variations in prices form part of a long-term trend

What is the Joseph Effect?

The Joseph Effect, which derives its name from a Biblical reference, is a phrase created by Benoit Mandelbrot, a Polish-born French-American mathematician. The phrase asserts that variations over time are normal and often part of wider trends and patterns, instead of being random. In essence, the Joseph Effect indicates whether variations in prices form part of a long-term trend. The measure is founded on the assumption that future events are greatly influenced by past events.

 

Joseph Effect

 

Summary

  • The Joseph Effect, which derives its name from a Biblical reference, is a phrase created by Benoit Mandelbrot, a Polish-born French-American mathematician.
  • The Joseph Effect indicates whether variations in prices form part of a long-term trend. It is founded on the assumption that future events are greatly influenced by past events.
  • The Joseph Effect makes reference to a verse in the Old Testament, which tells a story or recollection of a dream of a Pharaoh, as told by Joseph.

 

The Biblical Reference

The Joseph Effect makes reference to a verse in the Old Testament, which tells a story or recollection of a dream of a Pharaoh, as told by Joseph. The Pharaoh’s dream consisted of seven fat cows and seven lean cows, and in the dream, the fat cows were being consumed or eaten by the lean cows.

Hence, Benoit derived his theologies from the Biblical reference, following an interpretation that seven bad years would follow seven good years (crop harvesting). The seven good years are what is referred to as “The Joseph Effect,” whereas the seven bad years are termed “The Noah Effect.”

 

How the Joseph Effect Works

In mathematics (and/or statistics), the Joseph Effect can be quantified through the Hurst exponent. The Hurst exponent is typically used to measure the degree (or how much) of correlation of a series of prices (i.e., how much the prices are correlated with one another). It measures the regression toward the average over time for a series of price variations.

A Hurst exponent that falls between 0 and 0.5 shows that the data points in a series are not strongly correlated; therefore, they are not indicative of a long-term trend. A Hurst exponent that falls above 0.5 shows that the data points in a series are correlated and, therefore, indicate that the data points form part of a long-term pattern/trend.

 

The Hurst Exponent

The Hurst exponent is a statistical measure of a time series’ tendency to revert to a long-term pattern or equilibrium. The value for the exponent ranges from zero (0) to one (1).

  • A Hurst exponent of zero (0) indicates that any positive movement in the data points of a time series is directly followed by a negative movement in the data points. Hence, the long-term equilibrium remains constant.
  • A Hurst exponent of one (1) indicates a trending time-series. Any notable positive or negative movement in the data points of a time series is directly followed by a notable positive or negative movement in the data points.
  • A Hurst exponent of 0.5 indicates that there is no correlation between a variable or data point with a past value. It is also known as a Brownian Motion.

 

Applications of the Joseph Effect

The Joseph Effect is commonly used by investors to perform trend analysis, as the measure can be used to determine whether there is an existing trend that persists over time. When performing technical analysis, investors study existing trends (volume) and price variations.

 

Additional Resources

CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Advanced Technical Analysis
  • Bullish and Bearish
  • Regression Analysis
  • Triangle Patterns

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