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Using Entropy to Evaluate the Impact of Monetary Policy Shocks on Financial Networks
Petre Caraiani1,2, Alexandru Vasile Lazarec3
1Institute for Economic Forecasting, Romanian Academy, 050711 Bucharest, Romania.
Entropy (Basel, Switzerland)
|November 27, 2021
Summary
Monetary policy shocks, measured by unexpected changes in the US federal funds rate, decrease financial network entropy. This finding, using singular value decomposition and von Neumann entropy, holds across different network construction methods.
Area of Science:
- Economics
- Financial Markets
- Network Science
Background:
- Financial networks are complex systems influenced by economic factors.
- Monetary policy significantly impacts market dynamics and investor behavior.
Purpose of the Study:
- To investigate how monetary policy shocks alter the structure of financial networks.
- To quantify these changes using entropy measures.
Main Methods:
- Constructing financial networks from Dow Jones Industrial Average components.
- Applying singular value decomposition entropy and von Neumann entropy to measure network changes.
- Analyzing the impact of unexpected changes in the US federal funds rate.
Main Results:
- Unexpected positive monetary policy shocks lead to a reduction in financial network entropy.
- The observed decrease in entropy indicates a more ordered or less complex network structure.
- Results remain consistent across different window sizes for network construction.
Conclusions:
- Monetary policy plays a crucial role in shaping financial network complexity.
- Entropy measures effectively capture the impact of policy shocks on market structure.
- The choice of entropy measure can influence the interpretation of network changes.
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