Excess Out-of-Sample Risk and Fleeting Modes

TL;DR

This paper introduces a Random Matrix Theory-based method to detect fleeting modes, which are portfolios with significant excess risk indicating changes in asset correlations, applicable to futures and equity markets.

Contribution

It presents a universal, correlation-structure-independent test for fleeting modes and links momentum to excess risk in equity markets.

Findings

Fleeting modes exist in futures and equity markets.

The proposed test effectively detects excess risk.

Momentum is identified as a key source of excess risk.

Abstract

Using Random Matrix Theory, we propose a universal and versatile tool to reveal the existence of "fleeting modes", i.e. portfolios that carry statistically significant excess risk, signalling ex-post a change in the correlation structure in the underlying asset space. Our proposed test is furthermore independent of the "true" (but unknown) underlying correlation structure. We show empirically that such fleeting modes exist both in futures markets and in equity markets. We proposed a metric to quantify the alignment between known factors and fleeting modes and identify momentum as a source of excess risk in the equity space.