Efficient Markets Meet the Shannon Limit (The Shannon Limit, Relative Channel Capacity, and Price Uncertainty)

Abstract

A central concept of this paper is that information theory could help illuminate an important additional source of uncertainty in finance and economics. The communication constraints dictated by information theory have predictable results which fit well with the empirical realities and explain apparent anomalies seen in the markets. Furthermore the new relationships uncovered in this paper offer many novel and perhaps unexpected real life applications outside the realm of existing theories about uncertainty in finance and economics.

Keywords: financial engineering, information theory, Black-Scholes, implied volatility, chaos

JEL Classification: G1, G12, G14, E43