Dependence and Risk Management

Portfolio selection based on graphs: does Mr. Markowitz have his finger in the pie?

Some empirical studies suggest that the computation of certain graph structures from a (large) historical correlation matrix can be helpful in portfolio selection. In particular, a repeated finding is that information about the portfolio weights in the minimum variance portfolio (MVP) from classical Markowitz theory can be inferred from measurements of centrality in such graph structures. The present article compares the two concepts from a purely algebraic perspective. It is demonstrated that this heuristic relationship between graph centrality and the MVP is not inner-mathematical, at least not significantly strong. This means that empirically found relations between both concepts depend critically on the underlying historical data. Repeated empirical evidence for a strong relationship is hence shown to constitute a stylized fact of financial return time series, rather than the expected outcome of a heuristic similarity between both approaches.



Link to Paper