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Market Connectedness: Spillovers, Information Flow, and Relative Market Entropy

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  • Harald Schmidbauer

    () (Istanbul Bilgi University)

  • Angi Roesch

    () (FOM University of Applied Sciences, Munich)

  • Erhan Uluceviz

    () (Istanbul Bilgi University; Koç University-TÜSİAD ERF)

Abstract

The degree of connectedness of equity markets on a given day can be assessed by decomposing the forecast error variance resulting from a vector autoregressive model, applied to daily returns on stock indices. This well-known procedure leads, for each day, to a spillover matrix which can be readily interpreted as a network structure and summarized into the so-called spillover index, to which much recent research work has been devoted. Taking a sequence of spillover matrices as starting point, we show how the scope of this concept can be broadened in several ways. Firstly, we develop a concept to quantify a market's potential to spread information, which is related to the eigenvector structure of spillover matrices. Secondly, a Markov chain approach allows the definition of relative market entropy, quantifying the amount of information gained from day to day. A further entropy concept can be related to the speed of shock digestion and network stability. As an empirical example, we analyze a system of five markets represented by stock indices Dow Jones Industrial Average (USA), FTSE (UK), Euro Stoxx 50 (euro area), Nikkei 225 (Japan), and SSE Composite (China). It is demonstrated that increasing trends in the spillover index as well as in speed of information digestion are an empirical fact but no logical necessity theoretical examples show that there can be opposite trends in these series.

Suggested Citation

  • Harald Schmidbauer & Angi Roesch & Erhan Uluceviz, 2013. "Market Connectedness: Spillovers, Information Flow, and Relative Market Entropy," Koç University-TUSIAD Economic Research Forum Working Papers 1320, Koc University-TUSIAD Economic Research Forum.
  • Handle: RePEc:koc:wpaper:1320
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    References listed on IDEAS

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    Cited by:

    1. Harald Schmidbauer & Angi Rösch & Erhan Uluceviz & Narod Erkol, 2016. "Are American and European equity markets in phase? --- Frequency aspects of return and volatility spillovers," EcoMod2016 9559, EcoMod.

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