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Linear and nonlinear market correlations: Characterizing financial crises and portfolio optimization

Haluszczynski, Alexander and Laut, Ingo and Modest, Heike and Räth, Christoph (2017) Linear and nonlinear market correlations: Characterizing financial crises and portfolio optimization. Physical Review E, 96, 062315. American Physical Society. DOI: 10.1103/PhysRevE.96.062315 ISSN 1539-3755

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Official URL: https://link.aps.org/doi/10.1103/PhysRevE.96.062315

Abstract

Pearson correlation and mutual information-based complex networks of the day-to-day returns of U.S. S & P 500 stocks between 1985 and 2015 have been constructed to investigate the mutual dependencies of the stocks and their nature. We show that both networks detect qualitative differences especially during (recent) turbulent market periods, thus indicating strongly fluctuating interconnections between the stocks of different companies in changing economic environments. A measure for the strength of nonlinear dependencies is derived using surrogate data and leads to interesting observations during periods of financial market crises. In contrast to the expectation that dependencies reduce mainly to linear correlations during crises, we show that (at least in the 2008 crisis) nonlinear effects are significantly increasing. It turns out that the concept of centrality within a network could potentially be used as some kind of an early warning indicator for abnormal market behavior as we demonstrate with the example of the 2008 subprime mortgage crisis. Finally, we apply a Markowitz mean variance portfolio optimization and integrate the measure of nonlinear dependencies to scale the investment exposure. This leads to significant outperformance as compared to a fully invested portfolio.

Item URL in elib:https://elib.dlr.de/117966/
Document Type:Article
Title:Linear and nonlinear market correlations: Characterizing financial crises and portfolio optimization
Authors:
AuthorsInstitution or Email of AuthorsAuthors ORCID iD
Haluszczynski, AlexanderLMUUNSPECIFIED
Laut, IngoIngo.Laut (at) dlr.deUNSPECIFIED
Modest, HeikeHeike.Modest (at) dlr.deUNSPECIFIED
Räth, ChristophChristoph.Raeth (at) dlr.deUNSPECIFIED
Date:26 December 2017
Journal or Publication Title:Physical Review E
Refereed publication:Yes
Open Access:Yes
Gold Open Access:No
In SCOPUS:Yes
In ISI Web of Science:No
Volume:96
DOI :10.1103/PhysRevE.96.062315
Page Range:062315
Publisher:American Physical Society
ISSN:1539-3755
Status:Published
Keywords:time series, networks, nonlinear dynamics, econophysics
HGF - Research field:Aeronautics, Space and Transport
HGF - Program:Space
HGF - Program Themes:Research under Space Conditions
DLR - Research area:Raumfahrt
DLR - Program:R FR - Forschung unter Weltraumbedingungen
DLR - Research theme (Project):R - Komplexe Plasmen / Data analysis
Location: Oberpfaffenhofen
Institutes and Institutions:Institute of Materials Physics in Space > Research Group Complex Plasma
Deposited By: Räth, Christoph
Deposited On:22 Jan 2018 07:23
Last Modified:31 Jul 2019 20:15

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