The Relationship Between the US Economy’s Information Processing and Absorption Ratios: Systematic vs Systemic Risk

Abstract

After the 2008 financial collapse, the now popular measure of implied systemic risk called the absorption ratio was introduced. This statistic measures how closely the economy’s markets are coupled. The more closely financial markets are coupled the more susceptible they are to systemic collapse. A new alternative measure of financial market health, the implied information processing ratio or entropic efficiency of the economy, was derived using concepts from information theory. This new entropic measure can also be useful in predicting economic downturns and measuring systematic risk. In the current work, the relationship between these two ratios and types of risks are explored. Potential methods of the joint use of these different measures to optimally reduce systemic and systematic risk are introduced.

Keywords: Systemic Risk, Systematic Risk, Portfolio Management, Absorption Ratio, Information Processing Ratio, Shannon Entropy, Entropic Yield Curve, Regime Shift, Markov Switching Models

JEL Classification: G11, G12, G14, E3, E37, E4, E43, E47