Networks of Companies from Stock

Price Correlations

J. Kertész1,2, L. Kullmann1,
J.-P. Onnela2, A. Chakraborti2, K. Kaski2,
A. Kanto3
1Departmentof Theoretical Physics
Budapest University of Technology and Economics, Hungary
2Laboratory of Computational Engineering
Helsinki University of Technology, Finland
3Dept of Quantitative Methods in Economics and Management Science
Helsinki School of Economics, Finland
 Motivation
• Financial market is a self-adaptive complex system;
many interacting units, obvious networking.
Networks:
• Cooperation Most important and most difficult
• Activity, ownership
• Similarity

• Temporal aspects
• Networks generated by time dependencies
• Time dependent networks

• Revealing NW structure is crucial for understanding

and also for pragmatic reasons (e.g., portfolio opt.)

Many groups active: Palermo, Rome, Seoul etc.

 Outline

• Classification by Minimum Spanning

Trees (MST) (Mantegna)
• Temporal evolution
• Relation to portfolio optimization
• Correlations vs. noise: Parametric
aggregational classification
• Temporal correlations: Directed NW
of influence
 Data: price and return
• Daily price data for N=477 of NYSE stocks (CRSP of U. of
Chicago), such as GE, MOT, and KO
• Time span S=5056 trading days: Jan 1980 – Dec 1999

Daily closure price of GE:

PGE(t)

Daily logarithmic price:

lnPGE(t)

Daily logarithmic return:

rGE(t)=lnPGE(t) – lnPGE(t-1)
 Correlations and distances
For each window R t a correlation matrix Ct is defined with
N T N N
elements being the equal time correlation coefficients:
ri r j   ri r j 
 
t
, where  1   ijt  1
ij
r
i
2

  ri  2 r j   r j  2
2

where ri ,rj  Rt,  .. denotes time average. Transformation
to distance-matrix with elements:

dijt  2(1  ijt )  Dt , where 2  dijt  0

N N
Minimum spanning tree (MST), which is a graph linking N
vertices (stocks) with N-1 edges such that the sum of
distances is minimum. Efficient algorithms.
 Central vertex
To characterise positions of companies in the tree the
concept of central vertex is introduced:
• Reference vertex to measure locations of other vertices,
needed to extract further information from asset trees
• Central vertex should be a company whose price changes
strongly affect the market; three possible criteria:
(1) Vertex degree criterion: vertex with the highest vertex
degree, i.e., the number of incident edges; Local.
(2) Weighted vertex degree criterion: vertex with the
highest correlation coefficient weighted vertex degree;
Local.
(3) Center of mass criterion: vertex vi giving minimum
value for mean occupation layer (l(t,vi)); Global.
 Central vertex: comparison
(1) Vertex degree
criterion (local):
GE: 67.2%

(2) Weighted vertex

degree criterion
(local):
GE: 65.6%

(3) Center of mass

criterion (global):
GE: 52.8%
 Asset tree and clusters
Business sectors (Forbes)

Yahoo
data
 Potts superparamagnetic clustering

Kullmann, JK, Mantegna

Antiferromagnetic
bonds
 Asset tree clustering
Mismatch between tree clusters and business sectors?
1. Random price fluctuations introduce noise to the system
2. Business sector definitions vary by institutions (Forbes…)
3. Historical data should be matched with a contemporary
business sector definition
4. Classifications are ambiguous and less informative for
highly diversified companies
5. MST classification mechanism imposes constraint
6. Uniformity and strength of correlations vary by business
sector (c.f. Energy sector vs. Technology)
 Mean occupation layer
In order to characterise the spread of vertices on
the asset tree, concept of mean occupation layer
is introduced:
N
1
l (t , vc ) 
N
 lev( v )
i 1
t
i

where vc is the central vertex, lev(vi) denotes the

level of vertex vi , such that lev(vc) = 0.

Both static and dynamic central vertex may be

used: exhibit similar behaviour  Robustness
 Asset tree: topology change
Normal market topology crash topology

Yahoo
data
Robustness: single-step survival
Robustness of dynamic asset tree topology measured as
the ratio of surviving connections when moving by one step:
1
Single-step survival ratio:  t  E t  E t 1
N 1
T = 4 years, T = 1 month
Tree evolution: multi-step survival
Connections survived vs. time • Within the first region decay
1 is exponential
 t ,t  k  E t  E t 1    E t k
N 1 • After this there is cross-over
to power law behaviour:

Power law  (t,k) ~ t--z

decay: z ≈1.2
Half life vs. window width
T (y) t1/2 (y)
2 0.22
4 0.46
6 0.75

t1/2=0.12T
k=0
k=1
k=2
k=4
k=6
k=12
k=24
k=36
k=48
Distribution of vertex degrees

The topological nature of the network is

studied by analysing the distribution of
vertex degrees:
• Power law distribution would indicate scale-free
topology, a feature unexpected by random network
models

• Vandewalle et al. find for one year data   2.2

while we found 1.8  0.1    2.1  0.1

• Power law fit ambiguous due to limited range of data

 Distribution of vertex degrees

• L: normal
• R: crash
 Portfolio optimisation
In the Markowitz portfolio optimisation theory risks of
financial assets are characterised by standard deviations
of average returns of assets:
The aim is to optimise the asset weights wi so that the
overall portfolio risk is minimized for a given portfolio return
(minimum risk portfolio is uniquely defined)

1 N

2 i , j 1
wi w j Cov( ri , rj )  min

N
given r   wi ri
i 1
N
and w
i 1
i 1

No short - selling : wi  0

 Weighted portfolio layer
How are minimum risk portfolio assets located
on graph?
• Weighted portfolio layer is defined

by imposing no short-selling, i.e. wi  0, and it is

compared with the mean occupation layer l(t).
 Portfolio layer
No short-selling Short-selling
Static c.v. Static c.v.

Dynamic c.v. Dynamic c.v.

portfolio layer
mean occupation layer
 Correlations vs. noise
Correlation matrix contains systematics and noise.

MST: Non-parametric, unique classification scheme, but!

Even for uncorrelated random matrix MST would lead to
classification…
Meaningful clustering and robustness already signalize
significance.

Different methods to separate noise from information:

• Eigenvalue spectra (Boston, Paris)
• Independent/principal component analysis
(economists)
 Here: Building up the FCG
Tree condition may ignore important correlations.
(General classification problem)
Visualization through Parametrized Aggregated
Classification (PAC): Add links one by one to the graph,
according to their rank, started by the strongest and ended
with a Fully Connected Graph (FCG). Strongly correlated
parts get early interconnected, clustering coefficient
becomes high. Ci = # of -s / [k(k-1) / 2] where k is the
degree of node i
Price time series data for a set of 477 companies.
Window width T=1000 business days (4 years),
located at the beginning of the 1980’s

Comparison with random graph (obtained by shuffling the

data)
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 Elementary graph concepts
Graph size:
number of edges in the graph (variable)

Graph order:
number of vertices in the graph (constant)

Spanned graph order:

number of vertices in the subgraph spanned by the edges,
thus excluding the isolated vertices (variable)

These definitions can be applied also to clusters (two types)

(1) edge cluster
(2) vertex cluster

Edge clusters are more meaningful in the asset graph context

 Cluster growth
The growth patterns of clusters can be divided into four
topologically different types:
(I) Create a new cluster (two nodes and the incident edge)
when neither of the two end nodes are part of an existing
edge cluster (spanned cluster order +2, size +1)
(II) Add a node and the incident edge to an already existing
edge cluster (spanned cluster order +1, size +1)
(III) Merge two edge clusters by adding an edge between
them (combined spanned cluster size +1)
(IV) Add an edge to an already existing edge cluster, thus
creating a cycle in it (spanned cluster size +1)
 Cluster growth
N=477

empirical random
 Spanned graph order
N=477

empirical random
Number of vertex clusters
N=477

empirical random
Cluster size for edge clusters
N=477

empirical random
Vertex degree distribution
N=477 p=0.01

empirical random
Vertex degree distribution
N=477 p=0.25

empirical random
 Clustering coefficient
N=116

empirical random
Mean clustering coefficient
N=116

empirical random
 NO TIME REVERSAL SYM. ON THE MARKETS

Physics close to equilibrium: Time reversal symmetry (TRS) 

Detailed balance 
Symmetric correlation functions, Fluctuation Dissipation Th. (FDT)

No fundamental principle forcing TRS on the market.

In contrast: The elementary process, a transaction is irreversible:

Though the price is set by equilibrating supply and demand,
both parties (or at least one of them) feel that the
transaction is for their advantage and would not agree
to revert it.

Possibility of
• Asymmetry in the cross correlation functions
• Differences between the decay of spontaneous fluctuations
and of response to external perturbations
Time dependent cross correlations
log return of stock A between t and tt

Correlation fn between returns of company A and B

It depends on t and . Is it symmetric?

Difficulties:
• trade not syncronized, frequencies are very different
• bad signal/noise ratio

Approptiate averaging
 Toy model to test the method:
Persistent 1d random walk (increment x  1):

We take two such walks, which are correlated, with increments

x and y

The correlation function can be calculated:

(o=200,  =1000,  =0.99)

We corrupt the data to have similar quality to real ones

Only 1% of the data are kept.
The measured correlations on a finite set of data depends
on the averaging procedure (moving average)

The appropriate choice is t min  t  o

DATA set:
Trade And Quote, 10000 companies tick by tick
54 days: 195 companies traded more than 15000 times
t = 100s but results checked for 50-500s.
• We measure max, C(max), and R = C(max)/noise
• Consider Imax I > 100, C(max) > 0.04, and R > 6 as ‘effect’

Results

XON: Exxon
(oil)
ESV: Ensco
(oil wells)

• Not all pairs of comp’s show the effect

• Peak not only shifted but also asymmetric
• Large, frequently traded companies ‘pull’ the smaller ones
• Weak effect and short characteristic time (minutes)
 Directed network of influence

• No chains
• Many leaders for a follower
• Many followers for a leader
• Disconnected graph
 Conclusions

• Networks constructed from cross correlations of stock

price time series (MST, PAC)
• Though Cij noisy, much information content, useful for
portfolio optimization
• MST robust, reasonable classification, interesting dyn.
at crash-time
• Clusters (branches) not equally correlated, PAC reveals
differences, separation of noise from info
• Asymmetric time dependent cross correlations lead to
directed network of influence