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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.

Suggested Citation

  • Maximilian Vermorken & Ariane Szafarz & Hugues Pirotte, 2008. "Sector classification through non-Gaussian similarity," Working Papers CEB 08-032.RS, ULB -- Universite Libre de Bruxelles.
    • Handle: RePEc:sol:wpaper:08-032
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    References listed on IDEAS

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    1. repec:dau:papers:123456789/7748 is not listed on IDEAS
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    Cited by:

    1. Marie Brière & Ariane Szafarz, 2021. "When it rains, it pours: Multifactor asset management in good and bad times," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 44(3), pages 641-669, September.
    2. Bruzda, Joanna, 2017. "Real and complex wavelets in asset classification: An application to the US stock market," Finance Research Letters, Elsevier, vol. 21(C), pages 115-125.
    3. Waqas Nawaz & Muammer Koç, 2019. "Exploring Organizational Sustainability: Themes, Functional Areas, and Best Practices," Sustainability, MDPI, vol. 11(16), pages 1-36, August.
    4. Marie Briere & Ariane Szafarz, 2018. "Factors and Sectors in Asset Allocation: Stronger Together?," Working Papers CEB 18-016, ULB -- Universite Libre de Bruxelles.

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    More about this item

    Keywords

    equity sectors; industry classification; portfolio management;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G19 - Financial Economics - - General Financial Markets - - - Other

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