Network Models in Finance

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. 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.