Can we quantify the magnitude of shocks in financial markets like earthquakes? This paper introduces the Scale of Market Shocks (SMS), an event scale analogous to the Richter scale, to measure shocks using price volatilities. The SMS integrates volatilities over time, ranging from 1 hour to 42 days, utilizing high-frequency market data applicable to any market. By computing the SMS for the foreign exchange market, the study correlates SMS peaks with major world events. A high correlation between the SMS index and subsequent price movements is also demonstrated for short time intervals. This innovation enables a clearer understanding and quantification of market instability and its triggers.
As the International Journal of Theoretical and Applied Finance focuses on quantitative financial models and their applications, this paper introducing the Scale of Market Shocks (SMS) aligns well with the journal's scope. The SMS aims to quantify shocks in financial markets using price volatilities, offering a new approach to measuring and understanding market instability, which is relevant to the journal's readership.