'Adaptive Seriational Risk Parity' and other Extensions for Heuristic Portfolio Construction using Machine Learning and Graph Theory
Peter Schwendner, Jochen Papenbrock, Markus Jaeger and Stephan Krügel The Journal of Financial Data Science Fall 2021, jfds.2021.1.078; DOI: https://doi.org/10.3905/jfds.2021.1.078
Posted: 18 Mar 2021 Last revised: 7 Oct 2021
Date Written: March 17, 2021
In this article, the authors present a conceptual framework named 'Adaptive Seriational Risk Parity' (ASRP) to extend Hierarchical Risk Parity (HRP) as an asset allocation heuristic. The first step of HRP (quasi-diagonalization) determining the hierarchy of assets is required for the actual allocation in the second step of HRP (recursive bisectioning). In the original HRP scheme, this hierarchy is found using the single-linkage hierarchical clustering of the correlation matrix, which is a static tree-based method. The authors of this paper compare the performance of the standard HRP with other static and also adaptive tree-based methods, but also seriation-based methods that do not rely on trees. Seriation is a broader concept allowing to reorder the rows or columns of a matrix to best express similarities between the elements. Each discussed variation leads to a different time series reflecting portfolio performance using a 20-year backtest of a multi-asset futures universe. An unsupervised representation learning based on this time series data creates a taxonomy that groups the strategies in high correspondence to the structure of the various types of ASRP. The performance analysis of the variations shows that most of the static tree-based alternatives of HRP outperform the single linkage clustering used in HRP on a risk-adjusted basis. Adaptive tree methods show mixed results and most generic seriation-based approaches underperform.
Keywords: Hierarchical Risk Parity, portfolio allocation, hierarchical structure, seriation
JEL Classification: C15, G11, G17, G0, G1, G2, G15, G24, E44
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