How Fragile is your Portfolio?
Excessive complexity leads to fragility and resilience is the
antidote to fragility. Resilience may be measured based on
complexity thanks to the Quantitative Complexity Theory (QCT)
developed in 2003 [Ref. 1]. We know that, for example,
derivatives are said to be complex or even highly complex.
However, nobody has actually measured just how complex that is.
With the QCT this is today possible.
So, how can the resilience and complexity of a security, a portfolio
of stocks, or financial products such as derivatives be measured?
And what are the implications?
Portfolio complexity and resilience may be measured using
stock prices recorded over specific periods and with a given
frequency, depending on whether the investment is short,
mid or long-term.
Resilience provides a new means of measuring not only the
volatility of a stock or a stock portfolio but also the degree
of stability. This is of paramount importance since, as the
QCT confirms, excessively complex systems not only have
the capacity to deliver surprising behavior but they can also
fail in countless often non-intuitive ways.
The QCT-based methodology for designing portfolios and
asset allocation has been developed in 2013 and is the basis
of the new Complexity Portfolio Theory (CPT). The CPT
goes beyond the old concepts of the Modern Portfolio Theory.
Beside common principles, the CPT considers the resilience of each asset within the portfolio, that is, the degree of stability
which refers to the past stock performance. In 2013 Di Chen illustrated in his dissertation at the EPFL that complexity
influences negatively stock returns [Ref. 2]. In a nutshell: The less a portfolio is complex the more profitable it is. Moreover,
lower portfolio complexity makes it potentially more stable.
Wikirating offers together with Assetdyne the OntoNet™ system which measures the complexity and resilience of stocks and
stock portfolios and which introduces the concept of complexity to portfolio theory and design [Ref. 3]. If high complexity
implies high risk then measuring complexity becomes imperative.
Presentations:
English: wikirating_portfolio_stability_rating_EN.pdf
Deutsch: wikirating_portfolio_stability_rating_DE.pdf
For further information feel free to contact me: dorian.crede@wikirating.org
References
1.
2.
3.
”A New Theory of Risk and Rating" (ISBN 978-88-97260-00-4) , J. Marczyk, 2009
“Complexity and Cross-Sectional Returns”, D. Chen, EPFL (Financial Engineering Section), Aug. 2013
“Assetdyne LLC Develops Complexity Portfolio Theory (CPT) to Measure Intricacy and Resilience of Stock
Portfolios”, Reuters, Jan. 2014
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