Correlation Diversified Passive Portfolio Strategy Based on Permutation of Assets

Abstract

In this paper, we develop a passive strategy improving index investing, which we call Correlation Diversified Portfolio strategy. The proposed method adjusts weight vector of original index based on the permutation of assets composing the original index. We seek the permutation of assets such that assets with strong correlation to many other assets should be placed in the central part of permutation. By reducing the weights of assets placed in the central part of permutation, we can construct portfolios which are more diversified and have better risk-return characteristics than original index. To examine the usefulness and computational feasibility of the proposed method, we apply it to three major indices of US and Japan, and we provide numerical experiments. The numerical experiments show that portfolios constructed by the proposed method can achieve higher return with lower volatility than the original indices, while their behaviors are still similar to those of the original indices.

Keywords: index investing, Correlation Diversified Portfolio (CDP), permutation, quantum-inspired approach.

JEL Classification: G11