Procacci, PF;
Aste, T;
(2019)
Forecasting market states.
Quantitative Finance
, 19
(9)
pp. 1491-1498.
10.1080/14697688.2019.1622313.
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Abstract
We propose a novel methodology to define, analyse and forecast market states. In our approach market states are identified by a reference sparse precision matrix and a vector of expectation values. In our procedure each multivariate observation is associated to a given market state accordingly to a minimisation of a penalized Mahalanobis distance. The procedure is made computationally very efficient and can be used with a large number of assets. We demonstrate that this procedure is successfull at clustering different states of the markets in an unsupervised manner. In particular, we describe an experiment with one hundred log-returns and two states in which the methodology automatically associates states prevalently to per-and post crisis periods with one state gathering periods with average positive returns and the other state periods with average negative returns, therefore discovering spontaneously the common classification of ‘bull’ and ‘bear’ markets. In another experiment, with again one hundred log-returns and two states, we demonstrate that this procedure can be efficiently used to forecast off-sample future market states with significant prediction accuracy. This methodology opens the way to a range of applications in risk management and trading strategies in the context where the correlation structure plays a central role
| Type: | Article |
|---|---|
| Title: | Forecasting market states |
| Open access status: | An open access version is available from UCL Discovery |
| DOI: | 10.1080/14697688.2019.1622313 |
| Publisher version: | https://doi.org/10.1080/14697688.2019.1622313 |
| Language: | English |
| Additional information: | This version is the author accepted manuscript. For information on re-use, please refer to the publisher’s terms and conditions. |
| Keywords: | Financial market states; Temporal clustering; Information Filtering Networks; TMFG; LoGo; Sparse inverse covariance; Correlation Structure. |
| UCL classification: | UCL UCL > Provost and Vice Provost Offices > UCL BEAMS UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Engineering Science > Dept of Computer Science |
| URI: | https://discovery.ucl.ac.uk/id/eprint/10079529 |
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