Application of the ultrametric distance to portfolio taxonomy. Critical approach and comparison with other methods

Urszula Skórnik-Pokarowska and Arkadiusz Orłowski

We calculate the ultrametric distance between the pairs of stocks that belong to the same portfolio. The ultrametric distance allows us to distinguish groups of shares that are related. In this way, we can construct a portfolio taxonomy that can be used for constructing an efficient portfolio. We also construct a portfolio taxonomy based not only on stock prices but also on economic indices such as liquidity ratio, debt ratio and sales profitability ratio. We show that a good investment strategy can be obtained by applying to the portfolio chosen by the taxonomy method the so-called Constant Rebalanced Portfolio.

Physica A. Vol. 344, Issues 1-2