The Effects Of Bankruptcy On The Predictability Of Price Formation Processes On Warsaw’S Stock Market

In this study we investi gate how bankruptcy aff ects the market behaviour of prices of stocks on Warsaw’s Stock Exchange. As the behaviour of prices can be seen in a myriad of ways, we investi gate a parti cular aspect of this behaviour, namely the predictability of these price formati on processes. We approximate their predictability as the structural complexity of logarithmic returns. This method of analysing predictability of price formati on processes using informati on theory follows closely the mathemati cal defi niti on of predictability, and is equal to the degree to which redundancy is present in the ti me series describing stock returns. We use Shannon’s entropy rate (approximati ng Kolmogorov-Sinai entropy) to measure this redundancy, and esti mate it using the Lempel-Ziv algorithm, computi ng it with a running window approach over the enti re price history of 50 companies listed on the Warsaw market which have gone bankrupt in the last few years. This enables us not only to compare the diff erences between predictability of price formati on processes before and aft er their fi ling for bankruptcy, but also to compare the changes in predictability over ti me, as well as divided into diff erent categories of companies and bankruptcies. There exists a large body of research analysing the effi ciency of the whole market and the predictability of price changes en large, but only a few detailed studies analysing the infl uence of external sti muli on the effi ciency of price formati on processes. This study fi lls this gap in the knowledge of fi nancial markets, and their response to extreme external events.