Efficient construction of threshold networks of stock markets

TL;DR

This paper introduces a method to determine the optimal threshold for constructing stock market networks by maximizing dynamic consistency, successfully identifying key financial crises in historical data.

Contribution

It proposes a novel approach to select the threshold for stock networks based on dynamic consistency, improving the reliability of market structure analysis.

Findings

Optimal threshold estimated at 0.28 for S&P 500 stocks

Three major financial crises are clearly distinguished in network topology

Method enhances understanding of market evolution and crisis detection

Abstract

Although the threshold network is one of the most used tools to characterize the underlying structure of a stock market, the identification of the optimal threshold to construct a reliable stock network remains challenging. In this paper, the concept of dynamic consistence between the threshold network and the stock market is proposed. The optimal threshold is estimated by maximizing the consistence function. The application of this procedure to stocks belonging to Standard \& Pool's 500 Index from January 2006 to December 2011 yields the threshold value 0.28. In analyzing topological characteristics of the generated network, three globally financial crises can be distinguished well from the evolutionary perspective.