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Financial clustering in presence of dominant markets

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  • Edoardo Otranto
  • Romana Gargano

Abstract

Clustering financial time series is a recent topic of statistical literature with important fields of applications, in particular portfolio composition and risk evaluation. The risk is generally linked to the volatility of the asset, but its level of predictability also plays a basic role in investment decisions. In particular, the classification of a certain asset could be linked to its dependence on the volatility of a dominant market: movements in the volatility of the dominant market can provide similar movements in the volatility of the asset and its predictability would depend on the strength of this dependence. Working in a model based framework, we base the classification of the volatility of an asset not only on its volatility level, but also on the presence of spillover effects from a dominant market, such as the US one, and on the similarity of the dynamics of the asset and the dominant market. The method is carried out using an extended version of the Multiplicative Error Model and is applied to a set of European assets, also performing a historical simulation experiment. Copyright Springer-Verlag Berlin Heidelberg 2015

Suggested Citation

  • Edoardo Otranto & Romana Gargano, 2015. "Financial clustering in presence of dominant markets," Advances in Data Analysis and Classification, Springer;German Classification Society - Gesellschaft für Klassifikation (GfKl);Japanese Classification Society (JCS);Classification and Data Analysis Group of the Italian Statistical Society (CLADAG);International Federation of Classification Societies (IFCS), vol. 9(3), pages 315-339, September.
    • Handle: RePEc:spr:advdac:v:9:y:2015:i:3:p:315-339
    DOI: 10.1007/s11634-014-0189-z
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    Cited by:

    1. Giampiero M. Gallo & Demetrio Lacava & Edoardo Otranto, 2020. "On Classifying the Effects of Policy Announcements on Volatility," Papers 2011.14094, arXiv.org, revised Feb 2021.
    2. Khalifa, Ahmed A.A. & Otranto, Edoardo & Hammoudeh, Shawkat & Ramchander, Sanjay, 2016. "Volatility transmission across currencies and commodities with US uncertainty measures," The North American Journal of Economics and Finance, Elsevier, vol. 37(C), pages 63-83.

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    More about this item

    Keywords

    MEM; Unconditional volatility; Spillover effect ; Common dynamics; AR distance; 62H30; 91G70; 91G80;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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