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Using transfer entropy to measure information flows between financial markets

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  • Dimpfl, Thomas
  • Peter, Franziska J.

Abstract

We use transfer entropy to quantify information flows between financial markets and propose a suitable bootstrap procedure for statistical inference. Transfer entropy is a model-free measure designed as the Kullback-Leibler distance of transition probabilities. Our approach allows to determine, measure and test for information transfer without being restricted to linear dynamics. In our empirical application, we examine the importance of the credit default swap market relative to the corporate bond market for the pricing of credit risk. We also analyze the dynamic relation between market risk and credit risk proxied by the VIX and the iTraxx Europe, respectively. We conduct the analyses for pre-crisis, crisis and post-crisis periods.

Suggested Citation

  • Dimpfl, Thomas & Peter, Franziska J., 2012. "Using transfer entropy to measure information flows between financial markets," SFB 649 Discussion Papers 2012-051, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    • Handle: RePEc:zbw:sfb649:sfb649dp2012-051
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    References listed on IDEAS

    as
    1. Byström, Hans N. E., 2005. "Credit Default Swaps and Equity Prices: The Itraxx CDS Index Market," Working Papers 2005:24, Lund University, Department of Economics, revised 15 May 2005.
    2. Dötz, Niko, 2007. "Time-varying contributions by the corporate bond and CDS markets to credit risk price discovery," Discussion Paper Series 2: Banking and Financial Studies 2007,08, Deutsche Bundesbank.
    3. Pierre Collin-Dufresn & Robert S. Goldstein & J. Spencer Martin, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
    4. Virginie Coudert & Mathieu Gex, 2010. "The Credit Default Swap Market and the Settlement of Large Defaults," International Economics, CEPII research center, issue 123, pages 91-120.
    5. Seung Ki Baek & Woo-Sung Jung & Okyu Kwon & Hie-Tae Moon, 2005. "Transfer Entropy Analysis of the Stock Market," Papers physics/0509014, arXiv.org, revised Sep 2005.
    6. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2005. "An Empirical Analysis of the Dynamic Relation between Investment‐Grade Bonds and Credit Default Swaps," Journal of Finance, American Finance Association, vol. 60(5), pages 2255-2281, October.
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    More about this item

    Keywords

    entropy; information flow; non-linear dynamics; price discovery; credit risk; CDS;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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