Economy – Quantitative Finance – Statistical Finance
Scientific paper
2010-11-14
Physical Review E, Vol. 84, No. 2: 026109 (2011)
Economy
Quantitative Finance
Statistical Finance
15 pages, 10 figures, 1 table. Accepted for publication in Phys. Rev. E. v2 includes additional sections
Scientific paper
10.1103/PhysRevE.84.026109
We investigate financial market correlations using random matrix theory and principal component analysis. We use random matrix theory to demonstrate that correlation matrices of asset price changes contain structure that is incompatible with uncorrelated random price changes. We then identify the principal components of these correlation matrices and demonstrate that a small number of components accounts for a large proportion of the variability of the markets that we consider. We then characterize the time-evolving relationships between the different assets by investigating the correlations between the asset price time series and principal components. Using this approach, we uncover notable changes that occurred in financial markets and identify the assets that were significantly affected by these changes. We show in particular that there was an increase in the strength of the relationships between several different markets following the 2007--2008 credit and liquidity crisis.
Fenn Daniel J.
Johnson Neil F.
Jones Nick S.
McDonald Mark
Porter Mason A.
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