The Brexit is a process which has started two weeks ago and which will require a relatively long period of time in order to materialize with the departure of the UK from the EU. As the process unveils, it is interesting to monitor its effects. In particular, it is of interest to see its impact on global finance. The day the result of the referendum has been announced stock markets around the globe have reacted more or less nervously and with varying degree of intensity. What we have done is to actually measure the impact of the Brexit referendum (and its continuing fallout) on global finance by analyzing the Global Financial Complexity Index.
In general, when a system evolves and grows, its complexity increases. Increasing complexity points to lively activity and interaction, expanding information flow, higher intensity of processes and transformations which sustain and fuel the system in question. Shrinking complexity, on the other hand, indicates the opposite – deflation, decline, collapse, a general contraction and reduction of activity.
The GFCI – the Global Financial Complexity Index, or the Global FCI – is a meta index built on the major stock market indices. It has been shown that sudden and sustained drops of the Global FCI anticipate by a few weeks reductions of the Dow or the NASDAQ. In fact, when stock markets drop more or less sharply – pointing to momentary contractions – the Global FCI anticipates them by an earlier reduction of its value. Think of a sudden loss of weight, which points to potentially grave illness. Just like our organism is able to send early warnings, so does the GFCI. It’s only a matter of being able to interpret them.
Let’s examine the Global FCI as well as the Financial Complexity Indices of the US, EU, Asia-Pacific and Other Markets. In order to quantify the impact of the Brexit on the entire financial system and that of the mentioned macro-areas, we will measure the net difference between the value of the corresponding Financial Complexity Indices one month before the referendum and the day the result was announced, i.e. June 25-th, 2016.
The Global FCI had actually a small increase of 2%, what could be easily interpreted as noise. At the time of writing (10-th July, 2016) the GFCI shows neither evident signs of reaction to the Brexit nor did it hint anything noteworthy a month before the referendum (the red arrow indicates the Brexit referendum date, June 24-th, 2016).
Similar conclusions may be drawn when examining the US FCI – no major reaction after the referendum nor any indications of pre-referendum nervousness.
The Asia-Pacific FCI shows an evident increase, ruling out any major correlation with the Brexit.
In the case of the Other Markets, such as Sao Paulo, Buenos Aires, etc., the corresponding FCI behaves in a manner similar to that of Asia Pacific – a steady upward trend modulated by turbulence.
The EU FCI is a totally different story. From a value of 34.6, recorded on May 25-th, the FCI has fallen to 23.6, nearly a 32% reduction. At the rime of writing (July 10-th, 2016), the EU FCI has a value of 22.2, which implies a drop of 36% since May 25-th.
These results point to three things:
- From the point of view of the global financial system as reflected by the major stock markets, the reaction to the Brexit has been confined (so far) to the EU.
- The reaction of EU markets as a whole has been pretty dramatic. The EU FCI has fallen by 36% with respect to its value one month before the referendum.
- The EU FCI has been indicating an imminent drop of EU markets one month before it materialized. This is similar to how the GFCI anticipated drops in the Dow and in the NASDAQ. The writing was on the wall over a month in advance. Read earlier post.
It is interesting to observe that the effects of the Greek referendum (July 5-th, 2015) indicated by the black arrow, have been quite more pronounced. The US took it far more seriously. The EU markets have responded with more intensity and so did the global financial system. After all, everyone thought that a potential Grexit would initiate the demise of the European Union and, of course, a potential default of Greece that would send shock waves through the entire system. The Brexit is clearly less dramatic in that sense as no country is defaulting.
The effects of the Brexit – which is not an event but a potentially lengthy process – are being monitored and discussed (disputed) in the media, by politicians and experts (by the way, how can there be experts on the Brexit given that this is the first time it ever happens?). Our contribution to the discussion is quantitative. Serious science starts when you begin to measure.