Market Graph Clustering via QUBO and Digital Annealing

Seo Woo Hong, Pierre Miasnikof, Roy Kwon and Yuri Lawryshyn
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Seo Woo Hong: Department of Mechanical and Industrial Engineering, University of Toronto, Toronto, ON M5S 3G8, Canada
Pierre Miasnikof: Department of Chemical Engineering and Applied Chemistry, University of Toronto, Toronto, ON M5S 3E5, Canada
Roy Kwon: Department of Mechanical and Industrial Engineering, University of Toronto, Toronto, ON M5S 3G8, Canada
Yuri Lawryshyn: Department of Chemical Engineering and Applied Chemistry, University of Toronto, Toronto, ON M5S 3E5, Canada

JRFM, 2021, vol. 14, issue 1, 1-13

Abstract: We present a novel technique for cardinality-constrained index-tracking, a common task in the financial industry. Our approach is based on market graph models. We model our reference indices as market graphs and express the index-tracking problem as a quadratic K-medoids clustering problem. We take advantage of a purpose-built hardware architecture to circumvent the NP-hard nature of the problem and solve our formulation efficiently. The main contributions of this article are bridging three separate areas of the literature, market graph models, K-medoid clustering and quadratic binary optimization modeling, to formulate the index-tracking problem as a binary quadratic K-medoid graph-clustering problem. Our initial results show we accurately replicate the returns of various market indices, using only a small subset of their constituent assets. Moreover, our binary quadratic formulation allows us to take advantage of recent hardware advances to overcome the NP-hard nature of the problem and obtain solutions faster than with traditional architectures and solvers.

Keywords: graph clustering; K-medoids; market graph; combinatorial optimization; QUBO; portfolio construction; index-tracking (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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