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Modeling the Comovement of Entropy between Financial Markets
1Institute for Economic Forecasting, Romanian Academy, 050711 Bucharest, Romania.
Entropy (Basel, Switzerland)
|December 3, 2020
Summary
This study introduces a novel method to analyze financial market entropy comovement. It reveals interconnectedness, showing U.S. market entropy shocks impact other developed economies.
Area of Science:
- Quantitative Finance
- Econometrics
- Financial Market Analysis
Background:
- Financial markets exhibit complex dynamics and interconnectedness.
- Measuring market complexity and comovement is crucial for risk management.
- Entropy provides a robust measure of market uncertainty and information flow.
Purpose of the Study:
- To propose and apply a methodology for studying financial market entropy comovement.
- To investigate the impact of entropy shocks in one market on others.
- To identify common factors driving entropy in developed financial markets.
Main Methods:
- Entropy calculation using Singular Value Decomposition (SVD) on stock market index components.
- Analysis of comovement between entropy measures of selected developed economies (France, Germany, UK, US).
- Application of a Dynamic Factor Model (DFM) to entropy data.
Main Results:
- Demonstrated a methodology to quantify and compare financial market entropy.
- Quantified the spillover effects of entropy shocks from the US market to other economies.
- Identified a significant common factor influencing the entropy dynamics across the four markets.
Conclusions:
- Financial market entropy exhibits significant comovement and interconnectedness.
- The US financial market plays a notable role in influencing entropy dynamics in other developed markets.
- A common underlying factor drives the entropy movements, suggesting integrated market behavior.
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