Detecting Changes in Asset Co-Movement Using the Autoencoder Reconstruction Ratio

9 Pages Posted: 19 Feb 2020

See all articles by Bryan Lim

Bryan Lim

University of Oxford - Oxford-Man Institute of Quantitative Finance

Stefan Zohren

University of Oxford - Oxford-Man Institute of Quantitative Finance

Stephen Roberts

University of Oxford - Oxford-Man Institute of Quantitative Finance

Date Written: January 23, 2020

Abstract

Detecting changes in asset co-movements is of much importance to financial practitioners, with numerous risk management benefits arising from the timely detection of breakdowns in historical correlations. In this article, we propose a real-time indicator to detect temporary increases in asset co-movements, the Autoencoder Reconstruction Ratio, which measures how well a basket of asset returns can be modelled using a lower-dimensional set of latent variables. The ARR uses a deep sparse denoising autoencoder to perform the dimensionality reduction on the returns vector, which replaces the PCA approach of the standard Absorption Ratio, and provides a better model for non-Gaussian returns. Through a systemic risk application on forecasting on the CRSP US Total Market Index, we show that lower ARR values coincide with higher volatility and larger drawdowns, indicating that increased asset co-movement does correspond with periods of market weakness. We also demonstrate that short-term (i.e. 5-min and 1-hour) predictors for realised volatility and market crashes can be improved by including additional ARR inputs.

Suggested Citation

Lim, Bryan and Zohren, Stefan and Roberts, Stephen, Detecting Changes in Asset Co-Movement Using the Autoencoder Reconstruction Ratio (January 23, 2020). Available at SSRN: https://ssrn.com/abstract=3524654 or http://dx.doi.org/10.2139/ssrn.3524654

Bryan Lim (Contact Author)

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

Stefan Zohren

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

Stephen Roberts

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

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