Causal Discovery in Financial Markets: A Framework for Nonstationary Time-Series Data

A deeper comprehension of financial markets necessitates understanding not only the statistical dependencies among various entities but also the causal dependencies. This paper extends the Constraint-based Causal Discovery from Heterogeneous Data algorithm to account for lagged relationships in time-series data (an algorithm we call CD-NOTS), shedding light on the complex causal relations between different financial assets and variables. We compare the performance of different algorithmic choices, such as the choice of conditional independence test, to give general advice on the effective way to use CD-NOTS. Using the results from the simulated data, we apply CD-NOTS to a broad range of indices and factors in order to identify causal connections among the entities, thereby showing how causal discovery can serve as a valuable tool for factor-based investing, portfolio diversification, and comprehension of market dynamics. Further, we show our algorithm is a more effective alternative to other causal discovery algorithms since the assumptions of our algorithm are more realistic in terms of financial data, a conclusion we find is statistically significant.