Network Models in Finance

Expansive overview of theory and practical implementation of networks in investment management

Guided by graph theory, Network Models in Finance: Expanding the Tools for Portfolio and Risk Management provides a comprehensive overview of networks in investment management, delivering strong knowledge of various types of networks, important characteristics, estimation, and their implementation in portfolio and risk management. With insights into the complexities of financial markets with respect to how individual entities interact within the financial system, this book enables readers to construct diversified portfolios by understanding the link between price/return movements of different asset classes and factors, perform better risk management through understanding systematic, systemic risk and counterparty risk, and monitor changes in the financial system that indicate a potential financial crisis.

With a practitioner-oriented approach, this book includes coverage of:

• Practical examples of broad financial data to show the vast possibilities to visualize, describe, and investigate markets in a completely new way
• Interactions, Causal relationships and optimization within a network-based framework and direct applications of networks compared to traditional methods in finance
• Various types of algorithms enhanced by programming language codes that readers can implement and use for their own data

Network Models in Finance: Expanding the Tools for Portfolio and Risk Management is an essential read for asset managers and investors seeking to make use of networks in research, trading, and portfolio management.

Preface ix

Acknowledgments xv

About the Authors xvii

Part One

Chapter 1 Introduction 3

Chapter 2 The Basic Structure of a Network 29

Chapter 3 Network Properties 45

Chapter 4 Network Centrality Metrics 71

Part Two

Chapter 5 Network Modeling 95

Chapter 6 Foundations for Building Portfolio Networks – Link Prediction and Association Models 117

Chapter 7 Foundations for Building Portfolio Networks – Statistical and Econometric Models 141

Chapter 8 Building Portfolio Networks – Probabilistic Models 163

Chapter 9 Network Processes in Asset Management 181

Chapter 10 Portfolio Allocation With Networks 227

Part Three

Chapter 11 Systematic and Systemic Risk, Spillover, and Contagion 261

Chapter 12 Networks in Risk Management 277

References 313

Index 327

GUEORGUI S. KONSTANTINOV, PHD, has over 17 years’ experience in portfolio manage­ment, managing global bond portfolios and currencies for institutional investors and pension funds. He is an advisory board member of the Journal of Portfolio Management and the coauthor of Quantitative Global Bond ­Portfolio Management.

FRANK J. FABOZZI, PHD, is Professor of Practice at John Hopkins University’s Carey Business School. He has authored over 100 books and edited The Handbook of Fixed Income Securities and The Handbook of Mortgage-Backed Securities. He holds the CFA and CPA professional designations.

In Network Models in Finance: Expanding the Tools for Portfolio and Risk Management, a team of celebrated investment and finance educators and practitioners delivers a startlingly insightful and one-of-a-kind discussion of networks in investment management. Guided throughout by contemporary graph theory, the book explains how to identify and measure various types of networks and their characteristics in portfolio and risk management.

You’ll learn to construct diversified portfolios with reduced risk exposure by understanding the link between price and return movements of different asset classes and factors. You’ll also discover how to perform better risk management by understanding systematic, systemic, and counterparty risk and by monitoring changes in the financial system that indicate an incipient or potential financial crisis.

Network Models in Finance adopts a thoroughly “practitioner-­first” approach. It provides practical examples of broad financial data to show the impressive possibilities available to those who wish to visualize, describe, and investigate markets in an entirely new way. It also demonstrates the interactions, causal relationships, and optimizations within network-based frameworks and their direct applications to the financial markets.

Finally, the authors walk you through a variety of algorithms enhanced by tested code that you can implement immediately and use on your own datasets.

Perfect for asset managers and investors interested in making use of networks in research, trading, and portfolio management, Network Models in Finance is a must-read application of an effective, practical, and increasingly popular theory to the financial and investing markets.

NETWORK MODELS in FINANCE

An insightful exploration of the theory and application of networks as applied to investment management

Network Models in Finance: Expanding the Tools for Portfolio and Risk Management is a singularly incisive and unique discussion of networks and graph theory as applied to the financial and investment markets. Researchers and authors Gueorgui Konstantinov and Frank Fabozzi walk you through a comprehensive overview of networks in investment management, providing deep insight into their implementation in portfolio and risk management.

You’ll discover how to construct diversified and risk-optimized portfolios by linking the price and return movements of different asset classes and factors. You’ll also find out how to better manage risk by properly understanding systematic, counterparty, and systemic risk, and by monitoring changes in the financial system that may indicate a coming financial crisis.

Network Models in Finance delivers practical examples of a wide variety of financial data that can be used to visualize, describe, and investigate markets in an entirely new way, and explains the interactions and causal relationships that operate within a network-based framework.

This book is a must-read for investors, asset managers, and other finance practitioners with an interest in a largely underexplored area of investing.