Authors: Sónia R. Bentes
Addresses: Department of Finance and Economics – ISCAL, Av. Miguel Bombarda 20, 1069-035, Lisbon, Portugal; BRU-IUL, Av. das Forças Armadas, 1649-026, Lisbon, Portugal
Abstract: This paper examines the adequacy of entropy in assessing stock market volatility. To this end, we compare the traditional approach based on the standard deviation with the entropy method. In view of the fact that the Shannon entropy is only suitable for describing equilibrium systems we consider Renyi and Tsallis entropies, which are more appropriate to explain anomalous phenomena. We used a sample based on the daily returns of the G7's major stock market indices. The results show the limitations of the standard deviation-based approach in fully characterising volatility and highlight the potentialities of entropy as a measure of uncertainty.
Keywords: financial volatility; stock markets; entropy; statistical physics; risk; econophysics; uncertainty measures; stock trading; stock market volatility; G7; market indices; Renyi entropy; Tsallis entropy.
International Journal of Industrial and Systems Engineering, 2016 Vol.24 No.2, pp.158 - 177
Available online: 04 Aug 2016 *Full-text access for editors Access for subscribers Purchase this article Comment on this article