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Sector classification through non-Gaussian similarity

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  • Maximilian Vermorken
  • Ariane Szafarz
  • Hugues Pirotte

Abstract

Standard sector classification frameworks present drawbacks that might hinder portfolio manager. This paper introduces a new non-parametric approach to equity classification. Returns are decomposed into their fundamental drivers through Independent Component Analysis (ICA). Stocks are then classified according to the relative importance of identified fundamental drivers for their returns. A method is developed permitting the quantification of these dependencies, using a similarity index. Hierarchical clustering allows for grouping the stocks into new classes. The resulting classes are compared with those from the 2-digit GICS system for U.S. blue chip companies. It is shown that specific relations between stocks are not captured by the GICS framework. The method is applied on two different samples and tested for robustness.

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File URL: https://dipot.ulb.ac.be/dspace/bitstream/2013/14671/1/rou-0244.pdf
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Bibliographic Info

Paper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers CEB with number 08-032.RS.

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Length: 48 p.
Date of creation: Oct 2008
Date of revision:
Publication status: Published by: Université Libre de Bruxelles, Solvay Business School, Centre Emile Bernheim (CEB)
Handle: RePEc:sol:wpaper:08-032

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Keywords: equity sectors; industry classification; portfolio management;

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  1. Szafarz, Ariane & Brière, Marie, 2008. "Crisis-Robust Bond Portfolios," Economics Papers from University Paris Dauphine 123456789/7748, Paris Dauphine University.
  2. Michel Beine & Pierre-Yves Preumont & Ariane Szafarz, 2006. "Sector diversification during crises: a European perspective," DULBEA Working Papers 06-07.RS, ULB -- Universite Libre de Bruxelles.
  3. Farrell, James L, Jr, 1974. "Analyzing Covariation of Returns to Determine Homogeneous Stock Groupings," The Journal of Business, University of Chicago Press, vol. 47(2), pages 186-207, April.
  4. Andrew J. Patton, 2002. "On the out-of-sample importance of skewness and asymetric dependence for asset allocation," LSE Research Online Documents on Economics 24951, London School of Economics and Political Science, LSE Library.
  5. Roll, Richard, 1992. " Industrial Structure and the Comparative Behavior of International Stock Market Indices," Journal of Finance, American Finance Association, vol. 47(1), pages 3-41, March.
  6. Peiro, Amado, 1999. "Skewness in financial returns," Journal of Banking & Finance, Elsevier, vol. 23(6), pages 847-862, June.
  7. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
  8. Elton, Edwin J. & Gruber, Martin J., 1970. "Homogeneous Groups and the Testing of Economic Hypotheses," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 4(05), pages 581-602, January.
  9. Koedijk, Kees & Kole, Erik & Verbeek, Marno, 2006. "Selecting Copulas for Risk Management," CEPR Discussion Papers 5652, C.E.P.R. Discussion Papers.
  10. Thierry Vessereau, 2000. "Factor Analysis and Independent Component Analysis in Presence of High Idiosyncratic Risks," CIRANO Working Papers 2000s-46, CIRANO.
  11. Brown, Stephen J. & Goetzmann, William N., 1997. "Mutual fund styles," Journal of Financial Economics, Elsevier, vol. 43(3), pages 373-399, March.
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