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Hierarchical Minimum Variance Portfolios: A Theoretical and Algorithmic Approach

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  • Gamal Mograby

Abstract

We introduce a novel approach to portfolio optimization that leverages hierarchical graph structures and the Schur complement method to systematically reduce computational complexity while preserving full covariance information. Inspired by Lopez de Prados hierarchical risk parity and Cottons Schur complement methods, our framework models the covariance matrix as an adjacency-like structure of a hierarchical graph. We demonstrate that portfolio optimization can be recursively reduced across hierarchical levels, allowing optimal weights to be computed efficiently by inverting only small submatrices regardless of portfolio size. Moreover, we translate our results into a recursive algorithm that constructs optimal portfolio allocations. Our results reveal a transparent and mathematically rigorous connection between classical Markowitz mean-variance optimization, hierarchical clustering, and the Schur complement method.

Suggested Citation

  • Gamal Mograby, 2025. "Hierarchical Minimum Variance Portfolios: A Theoretical and Algorithmic Approach," Papers 2503.12328, arXiv.org.
  • Handle: RePEc:arx:papers:2503.12328
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    References listed on IDEAS

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    3. Michaud, Richard O. & Michaud, Robert O., 2008. "Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation," OUP Catalogue, Oxford University Press, edition 2, number 9780195331912, Decembrie.
    4. Benoit Mandelbrot & Adlai Fisher & Laurent Calvet, 1997. "A Multifractal Model of Asset Returns," Cowles Foundation Discussion Papers 1164, Cowles Foundation for Research in Economics, Yale University.
    5. Tumminello, Michele & Lillo, Fabrizio & Mantegna, Rosario N., 2010. "Correlation, hierarchies, and networks in financial markets," Journal of Economic Behavior & Organization, Elsevier, vol. 75(1), pages 40-58, July.
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