Learning Connections in Financial Time Series
Proceedings of the 30th International Conference on Machine Learning, PMLR 28(2):109-117, 2013.
To reduce risk, investors seek assets that have high expected return and are unlikely to move in tandem. Correlation measures are generally used to quantify the connections between equities. The 2008 financial crisis, and its aftermath, demonstrated the need for a better way to quantify these connections. We present a machine learning-based method to build a connectedness matrix to address the shortcomings of correlation in capturing events such as large losses. Our method uses an unconstrained optimization to learn this matrix, while ensuring that the resulting matrix is positive semi-definite. We show that this matrix can be used to build portfolios that not only “beat the market,” but also outperform optimal (i.e., minimum variance) portfolios.