Nonlinear shifts and dislocations in financial market structure and composition.

Abstract

This paper develops new mathematical techniques to identify temporal shifts among a collection of US equities partitioned into a new and more detailed set of market sectors. Although conceptually related, our three analyses reveal distinct insights about financial markets, with meaningful implications for investment managers. First, we explore a variety of methods to identify nonlinear shifts in a market sector structure and describe the mathematical connection between the measure used and the captured phenomena. Second, we study a network structure with respect to our new market sectors and identify meaningfully connected sector-to-sector mappings. Finally, we conduct a series of sampling experiments over different sample spaces and contrast the distribution of Sharpe ratios produced by long-only, long-short, and short-only investment portfolios. In addition, we examine the sector composition of the top-performing portfolios for each of these portfolio styles. In practice, the methods proposed in this paper could be used to identify regime shifts, optimally structured portfolios, and better communities of equities.