Forecasting Asset Dependencies to Reduce Portfolio Risk

Abstract

Financial assets exhibit dependence structures, i.e., movements of their prices or returns show various correlations. Knowledge of assets’ price dependencies can help investors to create a diversified portfolio, aiming to reduce portfolio risk due to the high volatility of the financial market. Since asset dependency changes with time in complex patterns, asset dependency forecast is an essential problem in finance. In this paper, we organize pairwise assets dependencies in an Asset Dependency Matrix (ADM) and formulate the problem of assets dependencies forecast to predict the future ADM given a sequence of past ADMs. We propose a novel idea viewing a sequence of ADMs as a sequence of images to capture the spatial and temporal dependencies among the assets. Inspired by video prediction tasks, we develop a novel Asset Dependency Neural Network (ADNN) to tackle the ADM prediction problem. Experiments show that our proposed framework consistently outperforms baselines on both future ADM prediction and portfolio risk reduction tasks.