The Use of Correlation Networks in Parametric Portfolio Policies

24 Pages Posted: 6 Oct 2014

See all articles by Harald Lohre

Harald Lohre

Robeco Quantitative Investments; Lancaster University Management School

Jochen Papenbrock

NVIDIA GmbH

Muddit Poonia

Indian Institute of Technology Kharagpur

Date Written: October 4, 2014

Abstract

Correlation networks reveal a rich picture of market risk structure dynamics. A rather compact and well-organized sector correlation network is indicative of a healthy market, whereas a widely spread sector correlation network characterizes a more fragile market environment. Intuitively, some characteristics of the correlation network can serve as natural measures of systemic risk. Pursuing an equity market timing strategy we document the predictive content of these measures to translate into a meaningful portfolio utility. Moreover, this result continues to hold when controlling for common predictors of the equity risk premium. Not only can correlation networks be useful as an aggregate market timing signal but also in navigating the cross-section of equity sectors. We especially document a significant outperformance of peripheral versus central equity sectors that cannot be explained by momentum or low volatility effects. Finally, we implement a parametric portfolio policy that comprises the complete information content of the sector network topology conditional on a given level of risk aversion.

Keywords: Correlation Networks, Parametric Portfolio Policies, Market Timing, Sector Allocation

JEL Classification: G11, G12, G14

Suggested Citation

Lohre, Harald and Papenbrock, Jochen and Poonia, Muddit, The Use of Correlation Networks in Parametric Portfolio Policies (October 4, 2014). Available at SSRN: https://ssrn.com/abstract=2505732 or http://dx.doi.org/10.2139/ssrn.2505732

Harald Lohre (Contact Author)

Robeco Quantitative Investments ( email )

Weena 850
Rotterdam, 3011 AG
Netherlands

Lancaster University Management School

Bailrigg
Lancaster LA1 4YX
United Kingdom

HOME PAGE: http://www.lancaster.ac.uk/lums/people/harald-lohre

Jochen Papenbrock

NVIDIA GmbH ( email )

Germany
+49-(0)1741435555 (Phone)

HOME PAGE: http://www.nvidia.com/en-us/industries/finance/

Muddit Poonia

Indian Institute of Technology Kharagpur ( email )

Kharagpur
IIT Khragpur
Kharagpur, IN West Bengal 721302
India

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