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Theory and applications of financial chaos index

Author

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  • Ataei, Masoud
  • Chen, Shengyuan
  • Yang, Zijiang
  • Peyghami, M. Reza

Abstract

We develop a new stock market index that captures the chaos existing in the market by measuring the mutual changes of asset prices. This new index relies on a tensor-based embedding of the stock market information, which in turn frees it from the restrictive value- or capitalization-weighting assumptions that commonly underlie other various popular indexes. We show that our index is a robust estimator of the market volatility which enables us to characterize the market by performing the task of segmentation with a high degree of reliability. In addition, we analyze the dynamics and kinematics of the realized market volatility as compared to the implied volatility by introducing a time-dependent dynamical system model. Our computational results which pertain to the time period from January 1990 to December 2019 imply that there exists a two-way causal relation between the processes underlying the realized and implied volatility of the stock market within the given time period. Specifically, we show that the latter has a stronger causal effect on the former as compared to the opposite. This result connotes that the implied volatility of the market plays a key role in characterization of the market’s realized volatility.

Suggested Citation

  • Ataei, Masoud & Chen, Shengyuan & Yang, Zijiang & Peyghami, M. Reza, 2021. "Theory and applications of financial chaos index," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 580(C).
    • Handle: RePEc:eee:phsmap:v:580:y:2021:i:c:s0378437121004337
    DOI: 10.1016/j.physa.2021.126160
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    References listed on IDEAS

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