A Heuristic for Approximating Extreme Negative Price Returns in Financial Markets

Abstract

This paper argues that one can calculate the probability of an asset's price displacement in a specific direction assuming the asset complies with the physical principle of least action. It first suggests that the price displacement of a financial asset is essentially dampened harmonic motion and then applies physical principles such as the Lagrangian and stationary action to analyze this motion. From this analysis, the paper constructs a method to predict the probability of an asset's price displacement in both magnitude and direction. Initial tests show that the method produces accurate probability predictions.