Global risk minimization in financial markets

TL;DR

This paper demonstrates that, under certain margin constraints, investors can globally minimize financial risk in portfolio models, using an approach analogous to physics, which could inform market stabilization strategies.

Contribution

It introduces a novel connection between risk minimization in finance and ground state computation in spin glass physics, offering a new method for risk management.

Findings

Risk minimization is achievable below a critical margin threshold.

The approach is mathematically equivalent to solving spin glass ground states.

Potential for regulatory policies to stabilize markets.

Abstract

Recurring international financial crises have adverse socioeconomic effects and demand novel regulatory instruments or strategies for risk management and market stabilization. However, the complex web of market interactions often impedes rational decisions that would absolutely minimize the risk. Here we show that, for any given expected return, investors can overcome this complexity and globally minimize their financial risk in portfolio selection models, which is mathematically equivalent to computing the ground state of spin glass models in physics, provided the margin requirement remains below a critical, empirically measurable value. For markets with centrally regulated margin requirements, this result suggests a potentially stabilizing intervention strategy.