Interconnectedness Risk and Active Portfolio Management

Journal of Investment Strategies, Forthcoming

Posted: 16 Jun 2016 Last revised: 1 Mar 2017

Date Written: June 16, 2016

Abstract

Interconnectedness is an alternative risk concept that so far has earned little attention in the asset management academia and industry. In this paper, we show that this neglect is not justified, as interconnectedness risk (i) has only moderate or no connection to conventional portfolio optimization inputs and (ii) active investment strategies based on interconnectedness information outperform their conventional peers. Utilizing a multi asset dataset, we measure interconnectedness risk by the embeddedness intensity, i.e. centrality, of assets in a correlation network, a concept from graph theory. Using the most common centrality measures, we first conduct empirical similarity studies analyzing how different centrality scores relate to each other and to conventional portfolio optimization inputs. Next, we outline how centrality can be incorporated in a risk-based as well as in a risk-return-based framework. Out-of-sample performance studies of centrality-optimized portfolios prove their competitiveness.

Keywords: Correlation Networks, Interconnectedness Risk, Contagion Risk, Minimum Spanning Trees, Active Portfolio Management, Centrality, Portfolio Optimization, Out-of-Sample Analysis

JEL Classification: G10, G11, C61

Suggested Citation

Baitinger, Eduard and Papenbrock, Jochen, Interconnectedness Risk and Active Portfolio Management (June 16, 2016). Journal of Investment Strategies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2796443 or http://dx.doi.org/10.2139/ssrn.2796443

Eduard Baitinger (Contact Author)

FERI Trust GmbH ( email )

Rathausplatz 8-10
Bad Homburg v.d.H, 61348
Germany

Jochen Papenbrock

Firamis ( email )

Robert-Kempner-Ring 27
Oberursel, 61440
Germany
+49 174 143 5555 (Phone)

HOME PAGE: http://www.firamis.de

Register to save articles to
your library

Register

Paper statistics

Abstract Views
1,318
PlumX Metrics