Quantifying impact and response in markets using information filtering networks

Isobel Seabrook, Fabio Caccioli and Tomaso Aste

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We present a novel methodology to quantify the 'impact' of and 'response' to market shocks. We apply shocks to a group of stocks in a part of the market, and we quantify the effects in terms of average losses on another part of the market using a sparse probabilistic elliptical model for the multivariate return distribution of the whole market. Sparsity is introduced with an L0-norm regularization, which forces to zero some elements of the inverse covariance according to a dependency structure inferred from an information filtering network. Our study concerns the FTSE 100 and 250 markets and analyzes impact and response to shocks both applied to and received from individual stocks and group of stocks. We observe that the shock pattern is related to the structure of the network associated with the sparse structure of the inverse covariance of stock log-returns. Central sectors appear more likely to be affected by shocks, and stocks with a large level of underlying diversification have a larger impact on the rest of the market when experiencing shocks. By analyzing the system during times of crisis and comparative market calmness, we observe changes in the shock patterns with a convergent behavior in times of crisis.

Keywords: stress testing; systemic risk; elliptical conditional probability; financial modeling (search for similar items in EconPapers)
JEL-codes: F3 G3 (search for similar items in EconPapers)
Pages: 12 pages
Date: 2022-06-01
New Economics Papers: this item is included in nep-dem and nep-net
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Published in Journal of Physics: Complexity, 1, June, 2022, 3(2). ISSN: 2632-072X

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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:115308

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