Complexity Economics

Innovation in Finance is Possible

The rating, a parameter that reflects the state of health of a company, occupies a central position in the world economy. Users of ratings are private and institutional investors, brokers, traders, analysts, and, lately, even politicians. Ratings, which are used essentially to decide which companies to invest in, are free and are published in newspapers and on the web. The process leading to the definition of the rating of a company is long and complex and has long been the focus of much discussion and controversy since it is often paid by the same companies being valued. Despite the conflict of interest is obvious, the largest international agencies – Moody’s, Standard & Poor ‘s and Fitch – continue to hold a rating monopoly. Who controls the rating agencies – largely companies that manage huge investment funds – has immense power. Everybody knows that. Everybody continues to use ratings.

We have always maintained that the rating process of a firm should be more transparent, objective and, above all, accessible even for the smallest of businesses. With this goal in mind we have launched the World’s first system ‘ self- rating’ system – Rate-A-Business – which allows anyone to upload data from the financial statements of a company and to obtain in a few seconds a measure of its state of health. The system works for both listed companies as well as for those not present on stock exchanges. In essence, the tool moves the process of rating from the agencies to the Internet, making it more “democratic”, fast and easily accessible by investors or even by smaller companies . In other words, the rating is transformed from a luxury to ‘commodity’. More than that, it becomes a useful tool in managing a business. This is the philosophy that inspires the Rate- A- Business platform.

How does Rate-A-Business work?

To obtain the rating with Rate-A-Business, whether it is for a listed companies or not, one must have quarterly data from the company’s income statement, cash flow, balance sheet or ratios. It is advisable to use data for the last 12 quarters (three years). A small example is shown below (the data is fictitious).

Once data has been uploaded the system processes the numbers, establishes the inter-dependencies between the various entries and measures the overall amount of “chaos” (uncertainty) contained within the data. Data entries with highly random or chaotic evolution are a reflection of a business that is not predictable and therefore difficult to manage, as in the example below.

Clearly, the more entries behave chaotically the more the company in question is vulnerable. Additionally, if these items are related to each other, the company is heavily exposed given that a problem with either of them can spread rapidly throughout the system. The degree of chaos that a company is able to withstand is called “critical complexity “. Near this threshold the trends of the various data entries is so uncertain and unpredictable that the company is virtually uncontrollable. Clearly, if, for example, the balance sheet entries have evolved chaotically , it is easy to imagine similar performance in terms of sales, production and, eventually, across the entire enterprise. So, the more a company functions far from threshold of its “critical complexity” it is more healthy. This, in summary, is the spirit of the new rating system available on the Rate A Business platform: measure the distance that separates a company from a state of “total chaos”.

How does Assetdyne works?

In the case of listed companies, the Assetdyne platform is connected in real time to different stock markets and collects the closing values of different securities. Using a technique similar to auto-correlation, the system assembles a table with those values going back a number of days. The system, at this point, measures the distance of these data from a state of “total chaos” (i.e. critical complexity ). The more the data in question are complex the more the evolution of the price of those securities results fragile and unpredictable. The operation of the system is very easy – one enters a ticker symbol and in a matter of seconds the system provides a measure of the complexity and resilience of its daily evolution.

As mentioned, high complexity implies chaos. As complexity approaches “critical complexity” the dynamics of the price per share becomes uncertain and therefore less resilient. To give an example, think of the value of cholesterol, which should be kept at a certain distance from a maximum value established by our physician. Near this threshold, our health is at risk. The situation with stocks and their dynamics is similar. If the trend is more complex (chaotic ) this increases the possibility of surprises and, therefore, the level of exposure. Complexity, therefore, provides a new measure of volatility (variability) which is not based on the conventional concepts of normality or linear correlation and which are questionable in a highly turbulent regime.

Resilience, on the other hand , which measures the ability to absorb shocks and extreme events, ranges from 0 % to 100%. The closer you get to 100 % the more predictable and stable the situation is. Low value of resilience point to situations which are chaotic, hence difficult to predict. Two examples of complexity and resilience rating systemic European banks are illustrated below:

Intesa Sanpaolo (ISPM.MI)
previous close
stock complexity
stock resilence

Credit Suisse Group (CS)
previous close
stock complexity
stock resilence
Portfolio ratings

Assetdyne’s rating platform is also applicable to portfolios of securities. Given that the computation of portfolio complexity is based on the closing prices at the end of the day, its value changes on a daily basis. It is, ultimately, a high-frequency portfolio rating system. It should be remembered that traditional ratings are generally issued once a year, when companies publish their consolidated financial statements. Given the speed of the economy, this may be inadequate.

One of the objectives of Assetdyne’s rating system is to indicate which are the securities or products which make a portfolio highly complex and which should be avoided by less experienced investors. What is surprising is that we all know that highly complex products are risky and yet no one has ever measured their actual complexity. Assetdyne does just that – for the first time we measure the complexity of stocks, portfolios of shares or other financial products.

As a final comment, one might conclude that stock markets constitute a huge social network in which millions of people participate in a global “game” called trading. One of the results of this game is the real-time share price of all the listed companies and which affects immediately the world’s economy. It is important, therefore, that every participant be aware of those financial products which hide high complexity, the most formidable source of fragility and risk.

*Assetdyne, has developed a new rating system for listed companies seeking to make the ratings as objective as possible by addressing the problem of potentially unreliable financial statements. This system is based on the concept of ‘crowd- rating ‘ and has its roots in the stock market.
The value of the shares of a company is the result of a complex interaction of millions of traders, analysts, investors, trading robots, etc. Ultimately, it is a reflection of the reputation and the perceived value of a company and is the result of a collective and ‘democratic’ process. Clearly, the value of a security is also driven by market trends, industry analysis, rumors, insider trading and other illegal practices and, of course, by the rating agencies. However, undeniably, it is the millions of investors who ultimately drive the price and the dynamics of the securities in accordance with the fundamental principles of supply and demand.

Assetdyne uses information about the daily value and the dynamics of the stock price of a company to actually calculate its rating. The rating that is calculated in this manner does not reflect the probability of default (i.e. the probability of bankruptcy) of a particular company – this is what a traditional rating produces, an AAA , BBB or CCC for instance – it reflects the complexity (degree of chaos) of the dynamics of its stock. This is very important for a number of reasons. Stocks with very complex dynamics are far more unpredictable than those with simpler dynamics. Highly complex and volatile dynamics are able to surprise investors, very often at the worst moment in time. It so happens that our economy and stock markets are not only very turbulent and chaotic , but also extremely complex. A rating based on the complexity of the stocks of listed companies reflects, therefore, the hallmark of our times – complexity.

Established originally in 2005 in the USA, Ontonix is a technology company headquartered in Como, Italy. The unusual technology and solutions developed by Ontonix focus on countering what most threatens safety, advanced products, critical infrastructures, or IT network security - the rapid growth of complexity. In 2007 the company received recognition by being selected as Gartner's Cool Vendor. What makes Ontonix different from all those companies and research centers who claim to manage complexity is that we have a complexity metric. This means that we MEASURE complexity. We detect anomalies in complex defense systems without using Machine Learning for one very good reason: our clients don’t have the luxury of multiple examples of failures necessary to teach software to recognize them. We identify anomalies without having seen them before. Sometimes, you must get it right the first and only time!

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