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Can PCA Structure Changes Indicate that it is Time to Trade?

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Abstract

We present some insights into the market and group components of the ASX200 based on a Principal Components Analysis (PCA). We firstly use biplots to identify which components should be considered market or group components. In our application this was component one for the market and components two to ten for the groups. We then investigated if changes in the structure of component two could be used in portfolio management. Our findings indicate that altering a portfolio structure based on changes in principal component structures are too short lived and involve too high transactions costs to be of use to a portfolio manager.

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  • Libin Yang & William Rea & Alethea Rea, 2015. "Can PCA Structure Changes Indicate that it is Time to Trade?," Working Papers in Economics 15/13, University of Canterbury, Department of Economics and Finance.
    • Handle: RePEc:cbt:econwp:15/13
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    File URL: https://repec.canterbury.ac.nz/cbt/econwp/1513.pdf
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    References listed on IDEAS

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    1. Dong-Hee Kim & Hawoong Jeong, 2005. "Systematic analysis of group identification in stock markets," Papers physics/0503076, arXiv.org, revised Oct 2005.
    2. Daniel J. Fenn & Mason A. Porter & Stacy Williams & Mark McDonald & Neil F. Johnson & Nick S. Jones, 2010. "Temporal Evolution of Financial Market Correlations," Papers 1011.3225, arXiv.org, revised May 2011.
    3. Henry Kaiser, 1970. "A second generation little jiffy," Psychometrika, Springer;The Psychometric Society, vol. 35(4), pages 401-415, December.
    4. repec:ebl:ecbull:v:7:y:2004:i:3:p:1-10 is not listed on IDEAS
    5. Kofman, Paul & Koedijk, Kees & Campbell, Rachel, 2002. "Increased Correlation in Bear markets: A Downside Risk Perspective," CEPR Discussion Papers 3172, C.E.P.R. Discussion Papers.
    6. M. Hossein Partovi & Michael Caputo, 2004. "Principal Portfolios: Recasting the Efficient Frontier," Economics Bulletin, AccessEcon, vol. 7(3), pages 1-10.
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    More about this item

    Keywords

    Principal component analysis; stock selection; diversification; stock portfolios;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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