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Information Entropy and Occurrence of Extreme Negative Returns
Keywords
differential entropy, stock market crash, logistic regression
Abstract
This study is intended to investigate the connection between the complexity of a capital market and the occurrence of dramatic decreases in transaction prices. The work hypothesis is that such episodes, characterized by sudden and dramatic decreases in transaction prices mostly occur in period of market inefficiency, when the level of complexity reaches a local minimum. In this regard, we introduce a complexity estimator, through differential entropy. The connection between the market complexity level and the appearance of extreme returns is illustrated in a logistic regression model.
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