Dynamic portfolio strategy using clustering approach

TL;DR

This paper introduces a dynamic portfolio strategy using clustering of stock networks that adapts to market conditions, improving investment performance in Chinese stock markets.

Contribution

It presents a novel two-stage portfolio selection method based on network topology and market condition analysis, tailored for Chinese stock markets.

Findings

Central portfolios outperform peripheral ones in bullish or stable markets.

Peripheral portfolios perform better in stable to downturn markets.

65-70% of strategies outperform random benchmarks in tested markets.

Abstract

The problem of portfolio optimization is one of the most important issues in asset management. This paper proposes a new dynamic portfolio strategy based on the time-varying structures of MST networks in Chinese stock markets, where the market condition is further considered when using the optimal portfolios for investment. A portfolio strategy comprises two stages: selecting the portfolios by choosing central and peripheral stocks in the selection horizon using five topological parameters, i.e., degree, betweenness centrality, distance on degree criterion, distance on correlation criterion and distance on distance criterion, then using the portfolios for investment in the investment horizon. The optimal portfolio is chosen by comparing central and peripheral portfolios under different combinations of market conditions in the selection and investment horizons. Market conditions in our paper are identified by the ratios of the number of trading days with rising index or the sum of the amplitudes of the trading days with rising index to the total number of trading days. We find that central portfolios outperform peripheral portfolios when the market is under a drawup condition, or when the market is stable or drawup in the selection horizon and is under a stable condition in the investment horizon. We also find that the peripheral portfolios gain more than central portfolios when the market is stable in the selection horizon and is drawdown in the investment horizon. Empirical tests are carried out based on the optimal portfolio strategy. Among all the possible optimal portfolio strategy based on different parameters to select portfolios and different criteria to identify market conditions, $65\%$ of our optimal portfolio strategies outperform the random strategy for the Shanghai A-Share market and the proportion is $70\%$ for the Shenzhen A-Share market.