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Detecting Changes in Asset Co-Movement Using the Autoencoder Reconstruction Ratio

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  • Bryan Lim
  • Stefan Zohren
  • Stephen Roberts

Abstract

Detecting changes in asset co-movements is of much importance to financial practitioners, with numerous risk management benefits arising from the timely detection of breakdowns in historical correlations. In this article, we propose a real-time indicator to detect temporary increases in asset co-movements, the Autoencoder Reconstruction Ratio, which measures how well a basket of asset returns can be modelled using a lower-dimensional set of latent variables. The ARR uses a deep sparse denoising autoencoder to perform the dimensionality reduction on the returns vector, which replaces the PCA approach of the standard Absorption Ratio, and provides a better model for non-Gaussian returns. Through a systemic risk application on forecasting on the CRSP US Total Market Index, we show that lower ARR values coincide with higher volatility and larger drawdowns, indicating that increased asset co-movement does correspond with periods of market weakness. We also demonstrate that short-term (i.e. 5-min and 1-hour) predictors for realised volatility and market crashes can be improved by including additional ARR inputs.

Suggested Citation

  • Bryan Lim & Stefan Zohren & Stephen Roberts, 2020. "Detecting Changes in Asset Co-Movement Using the Autoencoder Reconstruction Ratio," Papers 2002.02008, arXiv.org, revised Sep 2020.
  • Handle: RePEc:arx:papers:2002.02008
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    References listed on IDEAS

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    6. Frank J. Fabozzi & Rosella Giacometti & Naoshi Tsuchida, 2015. "The ICA-based Factor Decomposition of the Eurozone Sovereign CDS Spreads," IMES Discussion Paper Series 15-E-04, Institute for Monetary and Economic Studies, Bank of Japan.
    7. Fulvio Corsi, 2009. "A Simple Approximate Long-Memory Model of Realized Volatility," Journal of Financial Econometrics, Oxford University Press, vol. 7(2), pages 174-196, Spring.
    8. Diaa Noureldin & Neil Shephard & Kevin Sheppard, 2012. "Multivariate high‐frequency‐based volatility (HEAVY) models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 27(6), pages 907-933, September.
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    Cited by:

    1. Dragos Gorduza & Xiaowen Dong & Stefan Zohren, 2022. "Understanding stock market instability via graph auto-encoders," Papers 2212.04974, arXiv.org.
    2. Liang Zeng & Lei Wang & Hui Niu & Ruchen Zhang & Ling Wang & Jian Li, 2021. "Trade When Opportunity Comes: Price Movement Forecasting via Locality-Aware Attention and Iterative Refinement Labeling," Papers 2107.11972, arXiv.org, revised May 2023.
    3. Ioana Boier, 2022. "Multiresolution Signal Processing of Financial Market Objects," Papers 2210.15934, arXiv.org, revised Nov 2022.

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