Journal
ANNALS OF OPERATIONS RESEARCH
Volume 299, Issue 1-2, Pages 61-80Publisher
SPRINGER
DOI: 10.1007/s10479-019-03136-y
Keywords
Portfolio selection; Networks; Global minimum variance; Dependence structure
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The paper explores the role of network structure in financial markets to enhance portfolio selection, uncovering that optimal portfolios obtained through a network-based approach mainly consist of peripheral assets with a higher performance-risk trade-off compared to traditional methods. The methodology also offers a graphical visualization of the selected portfolio directly on the network layout, aiding in understanding the optimal strategy.
The main contribution of the paper is to unveil the role of the network structure in the financial markets to improve the portfolio selection process, where nodes indicate securities and edges capture the dependence structure of the system. Three different methods are proposed in order to extract the dependence structure between assets in a network context. Starting from this modified structure, we formulate and then we solve the asset allocation problem. We find that the optimal portfolios obtained through a network-based approach are composed mainly of peripheral assets, which are poorly connected with the others. These portfolios, in the majority of cases, are characterized by an higher trade-off between performance and risk with respect to the traditional global minimum variance portfolio. Additionally, this methodology benefits of a graphical visualization of the selected portfolio directly over the graphic layout of the network, which helps in improving our understanding of the optimal strategy.
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