Risk diversification: a study of persistence with a filtered correlation-network approach

TL;DR

This study analyzes the time evolution of equity return correlations using a filtered network approach, revealing how market structures change during crises and affect risk diversification strategies.

Contribution

It introduces a dynamic filtered network method to study correlation persistence and its implications for risk management during financial crises.

Findings

Correlation structures are stable in early 2000s but decline before the 2007-2008 crisis.

Post-crisis, correlation structures recover but differ from pre-crisis patterns.

Current correlation structures show decreasing persistence, indicating new market phases.

Abstract

The evolution with time of the correlation structure of equity returns is studied by means of a filtered network approach investigating persistences and recurrences and their implications for risk diversification strategies. We build dynamically Planar Maximally Filtered Graphs from the correlation structure over a rolling window and we study the persistence of the associated Directed Bubble Hierarchical Tree (DBHT) clustering structure. We observe that the DBHT clustering structure is quite stable during the early 2000' becoming gradually less persistent before the unfolding of the 2007-2008 crisis. The correlation structure eventually recovers persistence in the aftermath of the crisis settling up a new phase, distinct from the pre-cysts structure, where the market structure is less related to industrial sector activity. Notably, we observe that - presently - the correlation structure is loosing again persistence indicating the building-up of another, different, phase. Such dynamical changes in persistence and their occurrence at the unfolding of financial crises rises concerns about the effectiveness of correlation-based portfolio management tools for risk diversification.