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A network approach to unravel asset price comovement using minimal dependence structure

Pablo de Carvalho and Aparna Gupta

Journal of Banking & Finance, 2018, vol. 91, issue C, 119-132

Abstract: We develop a network representation-based methodology to aid an exploratory analysis of temporally evolving comovement in asset prices. This parsimonious order-n representation of the most significant comovement in asset prices, filtered by common factors, allows tackling a large number of assets and unraveling their complex comovement structure. Flexibility in choosing explanatory factors to suit the specific objectives of a study makes this methodology useful for portfolio analysis, risk parity approaches, and risk management decisions. We illustrate the features of the methodology for a set of major industry equity indices and to blue chip stocks, where we analyze the dynamic relevance of Fama–French factors. Investigating the network for more than 20 years, including the dot-com bust, global financial crisis, and European debt crisis, helps draw many insights. For instance, unexpected industries are seen to connect idiosyncratically through the dot-com bust. We demonstrate that a network factor model based portfolio allocation performs better than a regular factor model based allocation.

Keywords: Minimum spanning tree; Non-stationarity; Asset price dynamics; Network analysis; Factor model (search for similar items in EconPapers)
JEL-codes: C18 G12 G17 C52 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:jbfina:v:91:y:2018:i:c:p:119-132