Market structure explained by pairwise interactions

Abstract

Financial markets are a typical example of complex systems where interactions between constituents lead to many remarkable features. Here, we show that a pairwise maximum entropy model (or auto-logistic model) is able to describe switches between ordered (strongly correlated) and disordered market states. In this framework, the influence matrix may be thought as a dissimilarity measure and we explain how it can be used to study market structure. We make the link with the graph-theoretic description of stock markets reproducing the non-random and scale-free topology, shrinking length during crashes and meaningful clustering features as expected. The pairwise model provides an alternative method to study financial networks which may be useful for characterization of abnormal market states (crises and bubbles), in capital allocation or for the design of regulation rules.