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Hierarchical risk parity using security selection based on peripheral assets of correlation-based minimum spanning trees

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  • Cho, Younghwan
  • Song, Jae Wook

Abstract

This study proposes hierarchical risk parity portfolios using a new correlation matrix and security selection. We suggest a global motion subtracted correlation matrix, which eliminates the global motion in the cross-correlation matrix. Also, we suggest utilizing the peripheral assets of a correlation-based minimum spanning tree for security selection. The proposed portfolio strategies with security selection outperform benchmarks, showing their nature as smart beta strategies. Specifically, the full correlation with a small number and global motion subtracted correlation with a relatively large number of selected assets exhibit decent performances during the post-crisis bull markets and crisis-induced bear markets, respectively.

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  • Cho, Younghwan & Song, Jae Wook, 2023. "Hierarchical risk parity using security selection based on peripheral assets of correlation-based minimum spanning trees," Finance Research Letters, Elsevier, vol. 53(C).
    • Handle: RePEc:eee:finlet:v:53:y:2023:i:c:s154461232200784x
    DOI: 10.1016/j.frl.2022.103608
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    Cited by:

    1. Shreya Patki & Roy H. Kwon & Yuri Lawryshyn, 2024. "Centrality-Based Equal Risk Contribution Portfolio," Risks, MDPI, vol. 12(1), pages 1-17, January.

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