Forecasting Financial Market Structure from Network Features using Machine Learning

• URL: http://arxiv.org/abs/2110.11751v1
• Date: Fri, 22 Oct 2021 12:51:32 GMT
• Title: Forecasting Financial Market Structure from Network Features using Machine Learning
• Authors: Douglas Castilho, Tharsis T. P. Souza, Soong Moon Kang, Jo\~ao Gama and Andr\'e C. P. L. F. de Carvalho
• Abstract summary: We propose a model that forecasts market correlation structure from link- and node-based financial network features using machine learning. We provide empirical evidence using three different network filtering methods to estimate market structure, namely Dynamic Asset Graph (DAG), Dynamic Minimal Spanning Tree (DMST) and Dynamic Threshold Networks (DTN) Experimental results show that the proposed model can forecast market structure with high predictive performance with up to $40%$ improvement over a time-invariant correlation-based benchmark.
• Score: 0.6999740786886535
• License: http://creativecommons.org/licenses/by/4.0/
• Abstract: We propose a model that forecasts market correlation structure from link- and node-based financial network features using machine learning. For such, market structure is modeled as a dynamic asset network by quantifying time-dependent co-movement of asset price returns across company constituents of major global market indices. We provide empirical evidence using three different network filtering methods to estimate market structure, namely Dynamic Asset Graph (DAG), Dynamic Minimal Spanning Tree (DMST) and Dynamic Threshold Networks (DTN). Experimental results show that the proposed model can forecast market structure with high predictive performance with up to $40\%$ improvement over a time-invariant correlation-based benchmark. Non-pair-wise correlation features showed to be important compared to traditionally used pair-wise correlation measures for all markets studied, particularly in the long-term forecasting of stock market structure. Evidence is provided for stock constituents of the DAX30, EUROSTOXX50, FTSE100, HANGSENG50, NASDAQ100 and NIFTY50 market indices. Findings can be useful to improve portfolio selection and risk management methods, which commonly rely on a backward-looking covariance matrix to estimate portfolio risk.

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