SEMI-VARIANCE AND SEMI-CORRELATIONS

FOR FINANCIAL INVESTMENTS

GIAMPAOLO GABBI
Financial Management Department, University of Siena
Banking and Finance Area, SDA Bocconi - Milan
gabbi@unisi.it

Many studies show that international correlations have changed through time.
This phenomenon changed many portfolio managers’ practices, which are now
strictly linked with sectors behaviours. In order to give reason for this
management style, we provide some new evidences for correlation dynamics
among geographic areas and business sectors.
Nevertheless some researches offer theoretical basis for semi-variance
optimisation, fewer authors analyse its contribution to asset allocation. Here we
apply the concept to compare whether it applies efficiently to sectors and
countries.
The paper is aimed at answering to the following questions:
1) is short-term correlation useful for tactical asset allocation?
2) is it possible to estimate less volatile indexes of correlation, so to ease the
forecasting process?
3) how to obtain a good coherence with frameworks incorporating downside
risk as measure of risk?
4) can portfolios outperform those allocated with the usual correlation index?
Conclusions are that:
1) short-term correlation, if adequately modelled, can be fundamental to
implement a successful tactical asset allocation;
2) correlations lower volatile thanks to the application of semi-correlation
measure;
3) neural networks applied to benchmark returns generate good results,
especially in terms of direction, which is, in fact, the necessary input for the
application of semi-correlation to the asset allocation process;
4) finally, gap ratios among returns and volatility grow for both the groups and
extreme values of the frontiers and the upward of risk/return ratio is still better
for geographical diversification, especially in the minimum values of expected
returns.

1. INTRODUCTION
Many studies show that international correlations have changed through
time1. During the last years, globalisation has accelerated the process of
towards increasing positive values.

1
Solnik-Bouorelle-Le Fur (1996); Groenen-Franses (2000).

1
This phenomenon changed many portfolio managers’ practices, which are
now strictly linked with sectors behaviours. In order to give reason for this
management style, we provide some new evidences for correlation dynamics
among geographic areas and business sectors.
Many studies offer theoretical basis for semi-variance optimisation2. Fewer
authors analyse the contribution of semi-correlation to asset allocation3. Here
we try to apply the concept to compare whether it applies more efficiently to
sectors or to countries.
The paper is aimed at answering to the following questions:
5) is short-term correlation useful for tactical asset allocation?
6) is it possible to estimate less volatile indexes of correlation, so to ease
the forecasting process?
7) how to obtain a good coherence with frameworks incorporating
downside risk as measure of risk [Bramante – Gabbi (2001)]?
8) can portfolios outperform those allocated with the usual correlation
index [Harlow – Rao (1989); Harlow (1991)]?

2. SHORT-TERM CORRELATION AND TACTICAL ASSET

ALLOCATION
In our paper, we consider correlation computed on a short-term basis:
periods are six months long, in order to evaluate the opportunity to
implement a tactical asset allocation.
Moreover, portfolio managers who apply sector benchmarks to their
decisions must face the problem of time series shortage, which affects the
dataset.
In our empirical study we compare two large groups of equity benchmarks,
respectively observed for sectors and for countries, as shown in Table 1, for
the period January 1994 – January 2000.

2
Harlow (1991).
3
Erb, Harvey, Viskanta (1994).

2
 Table 1 – Morgan Stanley Indexes for Sectors and Countries
SECTORS COUNTRIES
ENERGY AUSTRALIA
MATERIALS AUSTRIA
CAPITAL GOODS BELGIUM
COMML SVC & SUPPL CANADA
TRANSPORTATION DENMARK
AUTO & COMPONENTS FINLAND
CONS DUR & APPAREL FRANCE
HOTELS REST & LEISURE GERMANY
MEDIA HONG KONG
RETAILING IRELAND
FOOD & DRUG RETL ITALY
FOOD BEV & TOBACCO JAPAN
HOUSE & PERS PROD NETHERLANDS
H CARE EQUIP & SVC NEW ZEALAND
PHARMA & BIOTECH NORWAY
BANKS PORTUGAL
DIVERS FINANCIAL SINGAPORE
INSURANCE SPAIN
REAL ESTATE SWEDEN
SOFTWARE & SERVICES SWITZERLAND
TECH HARD & EQUIPMENT UNITED KINGDOM
TELECOM SVC USA
UTILITIES WORLD

The analysis of correlation volatility through short-term rolling periods

shows that volatility correlation is, on average, 12,99 per cent for countries
(with MSCI World Index), and 10,19 per cent for sectors.

Figure 1 – Short-term rolling correlation of MSCI World Index with MSCI

sectors
1 1

0.8 0.8

0.6 0.6

0.4
0.4

0.2
0.2

0
0
1 10 19 28 37 46 55 64 73 82 91 100 109 118
1 10 19 28 37 46 55 64 73 82 91 100 109 118

-0.2
-0.2

-0.4
-0.4
ENERGY MATERIALS CAPITAL GOODS COMML SVC & SUPPL TRANSPORTATION AUTO & COMPONENTS
CONS DUR & APPAREL HOTELS REST & LEIS MEDIA
RETAILING FOOD & DRUG RETL FOOD BEV & TOBACCO

3
 1 1

0.8 0.8

0.6
0.6

0.4
0.4

0.2
0.2

0
1 10 19 28 37 46 55 64 73 82 91 100 109 118 0
1 10 19 28 37 46 55 64 73 82 91 100 109 118

-0.2
-0.2

-0.4
-0.4
HOUSE & PERS PROD H CARE EQUIP & SVC PHARMA & BIOTECH BANKS DIVERS FINANC INSURANCE
REAL ESTATE SOFTWARE & SERVICES TECH HARD & EQUIP TELECOM SVC UTILITIES

Figure 1 (for sectors) and Figure 2 (for countries) show how correlation,
usually considered substantially stable in the long run, can be considered an
important variable for tactical asset allocation, if satisfactorily forecast.

Figure 2 – Short-term rolling correlation of MSCI World Index with MSCI

countries
1.0 1.0

0.8 0.8

0.6 0.6

0.4 0.4

0.2 0.2

0.0 0.0
1 10 19 28 37 46 55 64 73 82 91 100 109 118 1 10 19 28 37 46 55 64 73 82 91 100 109 118

-0.2 -0.2

-0.4 -0.4

AUSTRALIA AUSTRIA BELGIUM CANADA DENMARK FINLAND FRANCE GERMANY HONG KONG IRELAND ITALY JAPAN

1.0 1.0

0.8 0.8

0.6 0.6

0.4 0.4

0.2 0.2

0.0 0.0
1 10 19 28 37 46 55 64 73 82 91 100 109 118 1 10 19 28 37 46 55 64 73 82 91 100 109 118

-0.2 -0.2

-0.4 -0.4

LUXEMBOURG NETHERLANDS NEW ZEALAND NORWAY PORTUGAL SINGAPORE SPAIN SWEDEN SWITZERLAND UNITED KINGDOM USA

Figure 3 and Figure 4 show a candlestick representation of global

correlation. The evidence is that sectors correlation is, on balance,
decreasing (black candlesticks), while countries correlation is increasing,
even though less intensively.

4
 Figure 3 – Global correlation candlestick (MSCI World vs. sectors)

100.00%

80.00%

60.00%

40.00%

20.00%

0.00%
ENE MAT CAP COM TRA AUT CON HOT MED RET FOO BEV HOU HEA PHA BAN FIN INS RES SOF TEC TEL UTI

-20.00%

-40.00%

-60.00%

-80.00%

-100.00%

Figure 4 – Global correlation candlestick (MSCI World vs. countries)

100.00%

80.00%

60.00%

40.00%

20.00%

0.00%
AUS AUT BEL CAN DEN FIN FRA GER HOK IRE ITA JAP NET NEZ NOR POR SIN SPA SWE SWI UK USA

-20.00%

-40.00%

-60.00%

-80.00%

-100.00%

5
Applying historical returns to a six months holding period, we derive the
efficient frontiers reproduced in Appendix A (sectors) and Appendix B
(countries). We observe how volatile portfolio composition is even rolling
time only by six months (Table 2).

Table 2 – Extreme values of efficient frontiers

SECTORS COUNTRIES
PERIODS MIN MAX MIN MAX
E[r] ó E[r] ó E[r] ó E[r] ó
1 0,02 4,36 9,94 7,65 -3,06 3,73 7,59 16,36
2 -2,70 3,59 6,63 5,69 -0,73 2,09 6,23 10,52
3 5,59 0,87 10,27 2,52 9,69 1,06 10,95 15,17
4 6,42 1,83 11,15 7,83 5,05 0,21 14,31 8,64
5 -0,50 1,68 5,15 6,34 2,19 0,40 10,58 8,75
6 0,97 2,57 8,77 7,27 4,34 1,28 17,97 10,84
7 3.02 1,81 14,20 8,29 9,73 2,18 22,11 9,33
8 -3,93 3,61 9,26 12,12 -3,90 6,02 15,98 15,94
9 6,64 3,25 17,96 7,63 7,54 2,23 29,74 13,52
10 3,83 6,84 13,57 12,69 4,20 7,91 15,97 24,43
11 -1,08 1,56 15,08 17,05 1,90 0,96 28,64 16,53
AVERAGE 1.66 2.91 11.09 8.64 3.36 2.55 16.37 13.64
ST. DEV. 3.50 1.61 3.63 3.76 4.44 2.32 7.46 4.52
RATIO 0.57 1.28 1.32 1.20

Here we can view how range is, on average, 9,43 for sectors (ó =3,41) and
13,01 for countries (ó =6,99). The ratio computed in the last row is simply

avg[E(r )]
r= [1]
avg(ó )

This means that, whether some portfolio managers wish to implement

tactical asset allocation should be able to forecast not only returns and
volatilities, but also correlation indexes, so to determine optimal asset
weights.

3. SEMI-CORRELATION CORRELATION
Recently different correlation formulas have been proposed, especially in
order to support financial decision processes. Accepted the idea that the last
correlation matrix hides some traps, because of static view of variance-
covariance, it should be better analyse the time series of these correlations,
as shown in Figure 1 and Figure 2.
Nevertheless, the implementation of the expected correlation values could be
complicated by short term volatility. Here we apply an already known

6
measure of correlation to verify whether it is useful for sector and country
datasets.
According to Erb, Harvey and Viskanta [1994], semi-correlation helps the
analyst to find out the evolution process of two variables through time, so to
decide whenever introduce them into a portfolio in order to diversify
financial assets.
Computed in the same way as the downside risk, the semi-correlation
“provides a measure of equity comovements in common up, common down,
and mixed markets”4.

We define up-up semi-correlation equation [2]

∑∑ n (x )( )
k h

ij i − x ⋅ yj − y
i =1 j =1
ρ x, y = [2]
∑ n (x ) ∑ n (y − y)
k h
2
−x ⋅
2
i. i .j j
i =1 i =1

solved for all xi > avg(x) and yi > avg(y).

Down-down correlation is the [2] solved for solved for all xi < avg(x) and yi
< avg(y).

While, mixed correlation is the [2] when xi > avg(x) and yi < avg(y) or when
when xi < avg(x) and yi > avg(y).

Possible benefits of this way to calculate correlation are:

1) it should be possible to estimate a less volatile indexes of
correlation, so to ease the forecasting process;
2) coherence with frameworks incorporating downside risk as measure
of risk [Bramante – Gabbi (2001)];
3) portfolios could be outperforming with respect those allocated with
the usual correlation index [Harlow – Rao (1989); Harlow (1991)].

Four different measures of correlation (global; up-up; down-down and up-

down) have been computed through 120 rolling periods. Table 3 shows the
average and volatility values for all the sectors and the world index.

4
Erb, Harvey and Viskanta [1994, 32]

7
Table 3 – Average Correlations (MSCI WORLD vs. MSCI sectors)
DOWN-DOWN
WORLD TOT CORR UP-UP CORR CORR MIXED CORR
AVG VOL AVG VOL AVG VOL AVG VOL

ENERGY 47.65 27.19 71.58 8.88 79.03 10.39 -54.49 6.38

MATERIALS 65.01 21.47 80.01 8.40 84.93 8.57 -53.61 9.95
CAPITAL GOODS 86.20 8.01 88.79 5.38 93.23 4.18 -43.44 11.04
COMML SVC & SUPPL 70.94 10.99 81.82 4.37 81.57 11.16 -55.92 10.23
TRANSPORT 66.27 19.93 82.86 6.37 84.94 6.70 -56.64 10.88
AUTO COMPONENTS 58.49 15.90 74.17 7.29 80.59 9.23 -55.48 6.59
CONS DUR & APPAREL 58.74 13.81 73.61 8.08 80.26 8.05 -53.96 9.17
HOTELS REST & LEISURE 67.00 12.46 78.40 6.38 83.74 7.44 -54.62 8.42
MEDIA 79.34 9.46 82.34 8.66 90.17 4.94 -54.72 9.65
RETAILING 70.06 18.14 80.61 9.23 85.72 6.05 -51.34 13.63
FOOD & DRUG RETL 60.79 19.79 76.06 7.80 82.46 9.04 -56.01 8.55
FOOD BEV & TOBACCO 60.69 32.01 79.19 9.76 81.95 13.65 -54.28 11.30
HOUSE & PERS PROD 54.22 23.10 77.25 8.02 79.85 12.76 -54.95 11.27
H CARE EQUIP & SVC 60.54 15.10 77.75 8.24 80.61 9.00 -62.63 8.10
PHARMA & BIOTECH 68.02 24.85 80.11 10.47 86.19 10.18 -53.13 11.91
BANKS 81.84 11.48 87.01 5.88 89.30 6.59 -46.86 16.92
DIVERS FINANC 82.69 9.34 86.62 5.36 92.74 3.96 -45.48 8.84
INSURANCE 77.43 12.92 84.74 6.99 87.53 6.90 -49.27 13.62
REAL ESTATE 47.76 18.09 67.43 8.10 77.77 8.14 -52.73 6.86
SOFTWARE & SERVICES 67.24 9.41 79.90 6.52 83.71 5.56 -47.23 9.85
TECH HARD & EQUIP 78.61 7.88 83.37 5.06 88.36 5.06 -52.68 11.58
TELECOM SVC 77.66 7.10 82.59 6.65 89.15 4.86 -45.41 11.27
UTILITIES 64.35 17.91 79.05 8.65 83.64 8.25 -53.35 8.43

8
The same analysis has been realised for geographic areas: Table 4 shows the
average and volatility values for all the countries and the world index as
well.

Table 4 – Average Correlations (MSCI WORLD vs. MSCI countries)

DOWN-DOWN
WORLD TOT CORR UP-UP CORR CORR MIXED CORR
AVG VOL AVG VOL AVG VOL AVG VOL

AUSTRALIA 34.44 12.70 66.25 6.82 75.15 8.64 -53.34 10.32

AUSTRIA 39.15 17.65 67.24 10.14 74.83 11.49 -49.19 10.83
BELGIUM 56.13 15.33 74.56 5.53 77.63 11.59 -54.35 7.48
CANADA 73.05 8.07 79.82 5.38 87.38 5.25 -50.87 8.60
DENMARK 47.77 16.64 69.70 7.57 75.58 8.51 -53.68 7.76
FINLAND 58.00 13.28 71.66 8.66 83.04 8.14 -51.12 9.75
FRANCE 70.73 10.19 78.22 4.61 85.79 5.64 -49.35 12.67
GERMANY 67.55 10.16 76.90 6.52 83.39 6.01 -46.17 7.54
HONG KONG 38.36 18.56 61.83 8.07 75.33 9.72 -51.56 7.95
IRELAND 43.78 15.63 65.60 7.74 76.73 10.37 -57.36 13.15
ITALY 60.57 11.85 74.09 5.46 83.62 5.36 -51.17 11.23
JAPAN 37.17 15.80 71.76 6.68 70.84 7.56 -51.44 11.59
NETHERLANDS 67.75 9.77 79.36 6.23 83.93 6.10 -51.22 11.43
NEW ZEALAND 18.24 12.97 62.45 7.25 69.65 8.62 -53.64 13.31
NORWAY 49.70 13.23 70.80 6.55 78.68 7.12 -51.56 11.07
PORTUGAL 47.55 15.62 64.69 8.82 80.39 7.93 -51.47 11.36
SINGAPORE 28.91 12.85 65.91 6.49 74.57 6.90 -54.88 10.95
SPAIN 64.51 10.70 76.57 6.53 85.06 5.81 -49.36 10.99
SWEDEN 60.19 13.60 74.28 6.11 82.32 7.57 -50.52 10.06
SWITZERLAND 64.17 14.15 77.97 6.62 82.05 6.54 -48.16 10.97
UNITED KINGDOM 69.08 7.97 79.74 5.20 85.86 4.45 -46.10 11.05
USA 87.38 3.78 89.61 4.72 93.09 2.42 -46.16 11.57

The first empirical evidence is the lower volatility that common up and
common down markets show than global correlation. The latter performs a
15,3 per cent volatility for sectors and 12,4 per cent for countries, while the
up-up correlation is respectively 7,1% and 6,7% and the down-down is 7,5%
and 7,2%.
Mixed markets outcomes are relatively more unstable (10,2% for sectors and
10,6% for countries) but still more predictable than the usual way to
compute correlation. Appendix C shows semi-correlations candlestick

9
figures, which offer a technical view of direction and range for every
benchmark in respect with MSCI World Index.
The best result comes from the sector benchmarks, both in sense of
decreasing volatility and in sense of higher negative correlation with mixed
markets.

Nevertheless, our results can be applied only when indexes directions can be
satisfactorily forecast. Next section will show some results obtained with a
neural network for all the dataset.

4. FORECASTING RETURNS

4.1. Chaotic and non linear dynamics

We know that time series generated by a chaotic process, if studied through
conventional statistical methods like autocorrelation function or spectral
analysis, come into view apparently random. Brock and al. [1987] proposed
a methodology useful to distinguish stochastic and deterministic processes
through a statistics able to verify the hypothesis of a series identically and
independently distributed (i.i.d). Ashley and Patterson [1989] and Hsieh
[1991] demonstrate that the independence of a variable from its past values
does not necessarily imply a white noise process. The alternative reason for
the i.i.d. are: chaos, non-stationarity and conditional heteroskedasticity.
Therefore, we adopted opportune tests [Barnett and Chen (1986); Frank and
Stengos (1988a/b)] like the dimension of correlation, the BDS test and the
Lyapunov exponent, in order to evaluate possible chaotic behaviours.
The dimension of correlation, independently by the time frequency,
increases linearly with m, and this suggests that the underlying data process
generation are primarily stochastic. Besides, the dimension assumes
relatively low values, between 1 and 2 and they are always below the
random model values.
The BDS tests [Brock, Dechert e Scheinkman, 1987] allow to verify whether
time series are identically and independently distributed, both for series
produced by chaotic systems and for non linear stochastic systems.
The high BDS values point out that it is not possible to accept the null
hypothesis of i.i.d. data, while they suggest that the generating process is non
linear. Besides, the BDS test disconnects the random model N(0,1) from the
chaotic one. The empirical evidences bring us to conclude that time series
are non linear even though not necessarily chaotic.
Peculiar characteristic of the chaotic systems is the dependence from the
starting conditions, with trajectories that diverge exponentially, despite very
similar initial values. The most important tool to quantify the dependence

10
from the initial conditions in a dynamic system is the Lyapunov exponents
[McCafferty et al., 1992 and Dechert and Gencay, 1993].
Our results are consistent with those previously obtained through the
dimension of correlation and seem to exclude the presence of a chaotic
regime. In fact, being the Lyapunov exponents negative for all the currencies
examined and all the frequencies, this is indicative of a stable generating
process.
All the empirical results show a strong evidence of the existence of linear
and non linear dependencies for all the examined financial time series, even
though deterministic chaos is not an explanation. These considerations are
coherent with the implementation of econometric models and neural
networks, in order to fit the linear and non linear components here observed.
Data properties authorise some conclusions:
1) time series are asymmetrical and leptokurtic, therefore non normal
distribution is a coherent result with that traditionally obtained for daily
and weekly observations;
2) dependencies found in data are not linked with a white noise
generating process; however, as well underlined by Hsieh [1991], it is
opportune to treat this conclusion with extreme caution, since the higher
the frequency the greater the probability of false dependencies, linked to
the market microstructure;
3) the possibility to describe the patterns through a little dimension
chaotic model has been clearly refused. This result is in contradiction
with a large part of financial literature which found a strong chaotic
component for daily and weekly time series.

4.2. Forecasting methodologies

Here we apply a back-propagation neural network characterised by three
layers, a logistic activation function, and constant leaning rate (0,1),
momentum (0,1) and initial weight (0,1). Our inputs are technical indicators
optimised on the one-period lead calculated for the target variable.
Technical indicators applied are:
1. Lower and Upper Bolling Bands5;

5
Bollinger Band High creates a band above and below price. Because the band is
created by adding the standard deviation of price to the moving average of price, the
band width is determined by the fluctuation in price over the last n time periods
(advantage of quick band width reaction to large movements in the market). Thus
the band widens when price fluctuates wildly and narrows when price shows very
little fluctuation. Adjustment of the time periods provides a means of focusing on
anything from short term trends to long term trends. Adjustment of the standard
deviation multiplier controls the relative width of the band and thus determines the
strength of the price movement needed for a price breakout (movement above the
band). A higher standard deviation multiplier increases the relative band width

11
2. Linear weighted moving average difference;
3. Linear extrapolation;
4. Linear regression;
5. Linear regression slope;
6. Linear weighted moving average;
7. Differential moving average;
8. Exponential moving average;
9. Lagged Exponential moving average;
10. Wilder’s RSI6.
Optimisation methods depend on: a) time periods used by the majority of
indicators (simple moving average, lag, change, etc.). b) exponential moving
average factor is used by all indicators based upon one or more exponential
moving average calculations; c) standard deviation time periods are used by
all indicators which calculate a standard deviation; d) linear regression time
periods are used by all indicators which are based upon linear regression.
Three datasets have been extracted with the following rule:
a) training set: 50 per cent;
b) test set: 20 per cent;
c) generalization set (out-of-sample): 30 per cent.
Since time series are built through rolling periods over the period 1994-2001,
we train the neural networks on 61 periods; we test them on 24 periods,
generalizing the results on 36 periods of six months each.
The pattern selection has been random, although it does not guarantee that
every pattern will be chosen an equal number of times. The weight updates
not only included the change dictated by learning rate, but also a portion of
the last weight change as well. Like momentum in physics, a high
momentum term will keep the network generally going in the direction it has
been going. Weight fluctuations will tend to be dampened by a high
momentum term7.

(stronger price movement needed for a breakout), while a lower standard deviation
multiplier decreases the relative band width (weaker price movement needed for a
breakout).
6
WilderRSI = 100 - ( 100 / (1 + RS))
where:
RS = Up / Down (equals zero if down=0).
Initially
Up = Sum of increases over last n time periods divided by n
Down = Sum of decreases over last n time periods divided by n
Remainder of time
Up = [ Previous Up * (n-1) + increase ] / n
Down = [ Previous Down * (n-1) + decrease ] / n
7
The same parameters have been used for correlations forecasts, showed in the next
section of the paper.

12
4.3. Forecasting results

The application of neural networks to benchmarks returns can be

synthetically reported in the following figures.

Table 5 contains error measures for every neural network computed in the
generalisation set (out-of-sample) for all the sector indexes (Appendix D
shows all the figures with actual and estimated data).

Table 5 – Out-of-sample forecast performance (MSCI sectors)

CORR
R squared r squared MSE MAE MIN AE MAX AE COEFF
ENERGY 0.7325 0.7407 0.003 0.042 0.001 0.104 0.8606
MATERIALS 0.8985 0.9044 0.001 0.026 0.001 0.080 0.951
CAPITAL GOODS 0.8052 0.8193 0.001 0.030 0.000 0.087 0.9051
COMML SVC & SUPPL 0.4404 0.5933 0.002 0.031 0.000 0.107 0.7703
TRANSPORT 0.7922 0.7924 0.001 0.028 0.001 0.079 0.8902
AUTO COMPONENTS 0.832 0.8472 0.001 0.030 0.000 0.076 0.9205
CONS DUR & APPAREL 0.8104 0.8148 0.002 0.037 0.001 0.110 0.9027
HOTELS REST & LEISURE 0.7887 0.8136 0.001 0.028 0.000 0.100 0.9020
MEDIA 0.8225 0.8226 0.004 0.043 0.001 0.180 0.9069
RETAILING 0.7745 0.7756 0.003 0.045 0.001 0.120 0.8807
FOOD & DRUG RETL 0.8734 0.9317 0.002 0.038 0.000 0.104 0.9653
FOOD BEV & TOBACCO 0.8429 0.8467 0.002 0.040 0.004 0.081 0.9202
HOUSE & PERS PROD 0.8014 0.8154 0.003 0.044 0.001 0.146 0.9030
H CARE EQUIP & SVC 0.8235 0.8313 0.003 0.042 0.002 0.124 0.9117
PHARMA & BIOTECH 0.7656 0.7697 0.003 0.037 0.000 0.116 0.8774
BANKS 0.7156 0.7185 0.002 0.041 0.001 0.101 0.8477
DIVERS FINANC 0.4748 0.4997 0.003 0.047 0.002 0.116 0.7069
INSURANCE 0.7859 0.8101 0.002 0.040 0.005 0.108 0.9001
REAL ESTATE 0.7899 0.8088 0.003 0.047 0.000 0.149 0.8993
SOFTWARE & SERVICES 0.7723 0.7834 0.013 0.089 0.006 0.237 0.8851
TECH HARD & EQUIP 0.9041 0.9076 0.005 0.053 0.003 0.160 0.9527
TELECOM SVC 0.8682 0.8815 0.003 0.04 0.004 0.208 0.9389
UTILITIES 0.7666 0.8001 0.001 0.027 0.002 0.097 0.8945

Table 6 contains the same error measures for the country indexes (Appendix
E shows the figures with actual and estimated values).

13
Table 6 – Out-of-sample forecast performance (MSCI countries)
CORR
R squared r squared MSE MAE MIN AE MAX AE COEFF
AUSTRALIA 0.4363 0.5063 0.002 0.032 0.001 0.105 0.7115
AUSTRIA 0.763 0.7668 0.003 0.042 0.002 0.193 0.8757
BELGIUM 0.8379 0.8559 0.002 0.039 0.004 0.156 0.9252
CANADA 0.7435 0.7488 0.005 0.046 0.003 0.273 0.8653
DENMARK 0.5557 0.6063 0.004 0.051 0.002 0.145 0.7786
FINLAND 0.7887 0.7889 0.027 0.110 0.001 0.567 0.8882
FRANCE 0.8029 0.8058 0.004 0.051 0.003 0.154 0.8977
GERMANY 0.7480 0.7591 0.007 0.067 0.005 0.209 0.8712
HONG KONG 0.7600 0.7860 0.010 0.076 0.005 0.245 0.8865
IRELAND 0.7918 0.7967 0.004 0.046 0.004 0.153 0.8926
ITALY 0.7624 0.7733 0.007 0.066 0.005 0.256 0.8794
JAPAN 0.7640 0.8033 0.004 0.045 0.001 0.161 0.8962
NETHERLANDS 0.7232 0.7468 0.004 0.053 0.003 0.169 0.8642
NEW ZEALAND 0.6201 0.6795 0.002 0.042 0.002 0.096 0.8243
NORWAY 0.7263 0.7555 0.003 0.048 0.002 0.187 0.8692
PORTUGAL 0.8421 0.843 0.006 0.064 0.000 0.159 0.9181
SINGAPORE 0.8913 0.8949 0.006 0.057 0.005 0.240 0.9460
SPAIN 0.7657 0.7664 0.007 0.065 0.005 0.220 0.8754
SWEDEN 0.8461 0.8508 0.008 0.063 0.000 0.330 0.9224
SWITZERLAND 0.6891 0.7114 0.005 0.054 0.002 0.161 0.8435
UNITED KINGDOM 0.6705 0.6747 0.002 0.036 0.001 0.094 0.8214
USA 0.6232 0.6624 0.003 0.040 0.004 0.188 0.8139
WORLD 0.6260 0.6638 0.002 0.039 0.003 0.124 0.8148

On average, statistical error measures award sector forecasts, rather than

geographical ones (Table 7).

Table 7 – Average out-of-sample forecast performance

MSCI SECTORS MSCI COUNTRIES
R squared 0.777 0.729
r squared 0.797 0.750
Mean squared error 0.003 0.006
Mean absolute error 0.040 0.054
Min. absolute error 0.002 0.003
Max. absolute error 0.121 0.199
Correlation coefficient 0.891 0.864

14
Determination coefficient, MAE and MSE can be misshapen indexes when
errors are in terms of direction. In fact, semi-correlation needs a good
forecast of co-movements and mixed ones.
If we measure reliability of estimates by path accuracy from one period to
the following one (Table 8), the results show that neural networks forecast
better countries indexes than sectors (92,17% vs. 88,45%).

Table 8 – Correct direction in out-of-sample data (per cent values)

SECTORS % COUNTRIES %
ENERGY 94.29 AUSTRALIA 85.71
MATERIALS 88.57 AUSTRIA 91.43
CAPITAL GOODS 88.57 BELGIUM 97.14
COMML SVC & SUPPL 77.14 CANADA 97.14
TRANSPORTATION 82.86 DENMARK 94.29
AUTO & COMPONENTS 94.29 FINLAND 97.14
CONS DUR & APPAREL 77.14 FRANCE 100.00
HOTELS REST & LEISURE 71.43 GERMANY 97.14
MEDIA 91.43 HONG KONG 91.43
RETAILING 88.57 IRELAND 91.43
FOOD & DRUG RETL 97.14 ITALY 82.86
FOOD BEV & TOBACCO 88.57 JAPAN 94.29
HOUSE & PERS PROD 85.71 NETHERLANDS 97.14
H CARE EQUIP & SVC 94.29 NEW ZEALAND 82.86
PHARMA & BIOTECH 91.43 NORWAY 82.86
BANKS 85.71 PORTUGAL 97.14
DIVERS FINANCIAL 85.71 SINGAPORE 91.43
INSURANCE 94.29 SPAIN 97.14
REAL ESTATE 85.71 SWEDEN 94.29
SOFTWARE & SERVICES 94.29 SWITZERLAND 91.43
TECH HARD & EQUIPMENT 97.14 UNITED KINGDOM 82.86
TELECOM SVC 94.29 USA 91.43
UTILITIES 85.71 WORLD 91.43
AVERAGE 88.45 AVERAGE 92.17

5. FORECASTING CORRELATIONS

Once determined expected returns, we must compare forecasting

performances over correlations time series, both in global terms, and the
three semi-correlation outcomes.
We apply the same forecasting rules to global and semi-correlation time
series: back-propagation neural network with three layers and logistic
activation function8.
We trained neural networks for each benchmark in respect with MSCI World
Index and each side of semi-correlations (up-up down-down, and mixed) so
to compare various outcomes for every group of variables.
Table 9 shows how sector global correlations forecasts are more consistent
than countries’. This is coherent with the evidence of Figure 3 and Figure 4.

8
For every technical detail, see section 4.

15
The interesting outcomes here are the lower predictability of semi-
correlation for sectors, especially down-down and mixed ones.

Table 9 – Global and Semi-Correlations Forecasts (MSCI WORLD vs. MSCI

sectors)
GLOBAL UP-UP DOWN-DOWN MIXED
AVG VOL AVG VOL AVG VOL AVG VOL
R squared 0.788 0.130 0.808 0.052 0.619 0.200 0.564 0.082
r squared 0.807 0.119 0.832 0.040 0.660 0.187 0.621 0.082
Mean squared error 0.006 0.006 0.001 0.001 0.004 0.003 0.004 0.002
Mean absolute error 0.041 0.014 0.025 0.005 0.026 0.013 0.041 0.016
Min. absolute error 0.001 0.001 0.001 0.001 0.000 0.000 0.001 0.001
Max. absolute error 0.296 0.160 0.094 0.035 0.174 0.108 0.172 0.088
Correlation coefficient 0.895 0.069 0.921 0.032 0.804 0.113 0.786 0.052

Moreover, the purpose of decreasing volatility is failed (mainly when both

markets are bearish). Similar outcomes can be seen in Table 10, but here
countries data benefits of semi-correlation fitting. This conclusion is
especially true in mixed markets phases, when diversification works better.

Table 10 – Global and Semi-Correlations Forecasts (MSCI WORLD vs. MSCI

countries)
GLOBAL UP-UP DOWN-DOWN MIXED
AVG VOL AVG VOL AVG VOL AVG VOL
R squared 0.502 0.264 0.588 0.232 0.545 0.253 0.635 0.241
r squared 0.586 0.185 0.681 0.103 0.591 0.229 0.693 0.202
Mean squared error 0.008 0.010 0.002 0.002 0.002 0.002 0.004 0.002
Mean absolute error 0.043 0.022 0.029 0.013 0.024 0.010 0.042 0.008
Min. absolute error 0.001 0.001 0.001 0.001 0.001 0.001 0.002 0.002
Max. absolute error 0.358 0.212 0.094 0.033 0.163 0.075 0.190 0.081
Correlation coefficient 0.754 0.130 0.823 0.064 0.750 0.170 0.823 0.127

This result is consistent with the ability to forecast the correct direction of
benchmark returns, as seen in Table 8, in particular for countries indexes.

16
6. EFFICIENT FRONTIERS

The last section of the paper is aimed at verifying whether portfolio

optimised using semi-correlation measures can actually, according Harlow –
Rao (1989) and Harlow (1991), outperform global correlation.
We implemented return forecasts with neural networks9. For all the 11
periods we got the direction forecast and then, we applied the suitable semi-
correlation. Then, we compared expected with definite results (already
showed in Table 2), so to evaluate whether and when this measure
concretely works.
Table 11 contains the minimum and maximum values of the efficient
frontiers
Table 11 – Extreme values of efficient frontiers computed with semi-
correlations
SECTORS COUNTRIES
PERIODS MIN MAX MIN MAX
E[r] ó E[r] ó E[r] ó E[r] ó
1 0.36 4.27 10.50 6.70 -3.05 2.91 8.85 15.27
2 -2.84 3.17 7.31 5.11 0.06 1.61 6.63 9.30
3 5.94 0.68 10.40 1.81 9.72 0.33 11.23 14.56
4 7.22 1.48 12.01 7.78 5.22 -0.58 15.86 7.46
5 0.43 1.64 5.82 6.21 1.54 0.05 10.85 7.87
6 1.92 2.17 9.02 7.25 4.69 1.17 18.78 10.40
7 3.14 1.20 14.32 7.79 8.41 1.28 23.55 9.07
8 -3.47 3.35 9.47 11.77 -3.59 5.18 17.69 15.22
9 7.44 2.88 18.27 6.81 8.08 1.37 30.58 12.75
10 3.88 6.24 14.55 11.70 3.90 6.95 16.82 23.27
11 -0.39 1.07 15.22 16.26 2.28 0.53 30.02 15.51
AVERAGE 2.15 2.56 11.54 8.11 3.39 1.89 17.35 12.79
ST. DEV. 3.58 1.58 3.56 3.69 4.25 2.19 7.66 4.44
RATIO 0.84 1.42 1.79 1.36

Table 12 shows the differences in average between extreme values of the

efficient frontiers and the relative ratio, computed as already seen in equation
[1].

9
Pagnoni – Gabbi (2001) find out a comparison of other forecasting methods, such
as historical, capital asset pricing, building block, applied to equity and bond
markets.

17
 Table 12 – Return and volatility gaps between global and semi-correlation
efficient frontiers
SECTORS COUNTRIES
MIN MAX MIN MAX
E[r] ó E[r] ó E[r] ó E[r] Ó
RETURN GAP 0.49 -0.35 0.45 -0.53 0.03 -0.66 0.98 -0.85
VOL GAP 0.08 -0.03 -0.07 -0.07 -0.19 -0.13 0.20 -0.08
RATIO 0.27 0.14 0.47 0.16

For all the expected returns we have an increasing value, especially for the
maximum values. This is coupled with a lower level of volatility, due to the
better definition of correlation in the optimising process.
Figure 5 and Figure 6 report all the spreads for every forecasting period,
respectively for sectors and countries.

Figure 5 – Return spreads (MSCI sectors)

11

10

-0.20 0.00 0.20 0.40 0.60 0.80 1.00

min max

18
 Figure 6 – Return spreads (MSCI countries)

11

10

-1.50 -1.00 -0.50 0.00 0.50 1.00 1.50 2.00

min max

Despite in periods 5 and 7 we note a negative spread, gap values grant

countries, coherently with outcomes in terms of ability to forecast returns
(section 4) and correlations (section 5).

7. CONCLUSIONS
Our study shows that in periods of high volatility in correlation coefficients,
the application of the phase indicator can facilitate the process of
optimisation in building financial portfolios.
The answers offered by the study are:
5) short-term correlation, if adequately modelled, can be fundamental
to implement a successful tactical asset allocation. Decisive can be
the existence of numerous cycle inversions in correlation.
6) We obtained correlations lower volatile thanks to the application of
semi-correlation measure. The evidence is that the up-up correlation
is 7,1% for sectors and 6,7% for countries, while down-down
correlation is 7,5% and 7,2%. Mixed markets outcomes are
relatively unstable.
7) Neural networks applied to benchmark returns generate good results,
especially in terms of direction: this is, in fact, the necessary input

19
 for the application of semi-correlation to the asset allocation process.
Outcomes confirm that if applied to countries, the model works
better: direction residuals are 11,55% for sectors and 7,83% for
countries.
8) Finally, expected returns and semi-correlations have been used to
build the efficient frontiers. Results that is worth quoting are:
a. Gap ratios among returns and volatility grow for both the
groups and extreme values of the frontiers;
b. The upward of risk/return ratio is still better for
geographical diversification, especially in the minimum
values of expected returns.

REFERENCES

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and have Strange Attractions, in W. Barnett, E. Berndt and H. R White (eds),
Dynamic Econometric Modelling. Cambridge: Cambridge University Press.
Bramante, Colombo, Gabbi, 1998, Are Neural Network and Econometric Forecasts Good for
Trading? Stochastic Variance Model as a Filter Rule, in A.-P. N. Refenes – A. N.
Burgess – J. E. Moody (eds), Decision Technologies for Computational Management
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Brock W.A., Dechert W.D., Scheinkman J.A., 1987, A Test for Independence Based on the
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Harlow, Rao, 1989, Asset Pricing in a Generalized Mean-Lower Partial Moment Framework,
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Hsieh D. A., 1991, Chaos and Nonlinear Dynamics: Application to Financial Market, The
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Pagnoni, Gabbi, 2001, Tactical Asset Allocation and Time Diversification for Bond and
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21
Appendix A
Short-term (6 months) holding period efficient frontiers
(MSCI sectors)

Appendix B
Short-term (6 months) holding period efficient frontiers
(MSCI countries)

Appendix C
Correlation Candlestick

Appendix D
Generalization sets MSCI sectors

Appendix D
Generalization sets MSCI countries

22
Appendix A – Short-term (6 months) holding period efficient frontiers (MSCI
sectors)

Expected Return MSCI Machinery & Engineering TR

10.0 Expected Return
7.0
9.0 MSCI Automobiles TR MSCI Indust Components TR 6.5
MSCI Health & Personal Care TR
6.0
8.0 MSCI Financial Services TR
5.5
MSCI Chemicals TR MSCI Construct & Housing TR
7.0 5.0
4.5 MSCI Food & Hshold Prod TR
6.0
MSCI Recreation, Cons Goods TR 4.0
5.0 3.5
MSCI Transport - Road&Rail TR 3.0 MSCI Broadcast & Publish TR MSCI Forest Prod & Paper TR
4.0 MSCI Misc Materials&Commod TR 2.5
MSCI Business & Public ServMSCI
TR Energy Sources TR
3.0 MSCI Banking TR 2.0
MSCI Forest Prod & Paper TR MSCI Insurance TR
MSCI Business & Public Serv TR 1.5 MSCI Misc Materials&Commod TR
2.0 MSCI Electrical & Electronics TR
1.0
MSCI Energy Sources TR
1.0 0.5 MSCI Utilities - Elec&Gas TR MSCI Chemicals TR
MSCI Electrical & Electronics TR MSCI Leisure & Tourism TR
MSCI Building Mat & Construct TR MSCI Machinery & Engineering TR
0.0
0.0 MSCI Health & Personal Care TR MSCI Telecomm TR
MSCI -0.5 MSCI Recreation, Cons Goods TR
MSCI Food & Hshold Prod TR Telecomm TR MSCI Indust Components TR
-1.0 MSCI Leisure & Tourism TR -1.0
MSCI Insurance TR MSCI Building Mat & Construct TR
MSCI Broadcast & Publish TR -1.5 MSCI Banking TR
-2.0 MSCI Automobiles TR
-2.0
MSCI Real Estate TR
-3.0 -2.5
-3.0 MSCI Transport - Road&Rail TR MSCI Financial Services TR
-4.0 MSCI Utilities - Elec&Gas TR
-3.5

-5.0 -4.0
-4.5
-6.0
-5.0 MSCI Construct & Housing TR
-7.0 -5.5
MSCI Real Estate TR
-6.0
-8.0 -6.5

-9.0 -7.0

0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 4.4 4.8 5.2 5.6 6.0 6.4 6.8 7.2 7.6 8.0 8.4 8.8 9.2 9.6 10.0
-10.0 Standard Deviation (Risk)
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0
Standard Deviation (Risk)

Expected Return
11.0
Expected Return
10.5 12.0
11.5
10.0 MSCI Health & Personal Care TR
11.0
MSCI Recreation, Cons Goods TR MSCI Financial Services TR
9.5 10.5
MSCI Business & Public Serv TR 10.0
9.0 MSCI Health & Personal Care TR
9.5
8.5 MSCI Broadcast & Publish TR 9.0
8.5
8.0
8.0
MSCI Electrical & Electronics TR
7.5 7.5
MSCI Insurance TR MSCI Real Estate TR
7.0
7.0 MSCI Leisure & Tourism TR MSCI Forest Prod & Paper TR MSCI Electrical & Electronics TR
MSCI Telecomm TR
6.5
6.5 6.0 MSCI Business & Public Serv TR
MSCI Financial Services TR MSCI Leisure & Tourism
MSCI TR
Automobiles TR
MSCI Insurance TR MSCI Real Estate TR 5.5 MSCI Chemicals TR
6.0 MSCI Energy Sources TR 5.0
MSCI Transport - Road&Rail TR MSCI Food & Hshold Prod TR MSCI Banking TR
5.5 MSCI Telecomm TR 4.5 MSCI Broadcast & Publish TR
MSCI Energy Sources TRMSCI Machinery & Engineering TR
MSCI Banking TR 4.0
5.0 MSCI Chemicals TR 3.5 MSCI Utilities - Elec&Gas TR
MSCI Utilities - Elec&Gas TR MSCI Indust Components TR
4.5 3.0
2.5
4.0 MSCI Food & Hshold Prod TR MSCI Recreation, Cons Goods TR Misc Materials&Commod TR
MSCI 2.0 MSCI Transport - Road&Rail TR MSCI Misc Materials&Commod TR

1.5 MSCI Building Mat & Construct TR

3.5 MSCI Building Mat & Construct TR MSCI Construct & Housing TR
MSCI Construct & Housing TR 1.0
3.0 0.5
MSCI Machinery & Engineering TR 0.0
2.5
-0.5
2.0 -1.0
MSCI Indust Components TR -1.5
1.5
-2.0
1.0 -2.5 MSCI Forest Prod & Paper TR
MSCI Automobiles TR -3.0
0.5
-3.5
0.0 -4.0
-4.5
-0.5 -5.0
-1.0 0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 4.4 4.8 5.2 5.6 6.0 6.4 6.8 7.2 7.6 8.0 8.4 8.8 9.2 9.6 10.0
Standard Deviation (Risk)
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 12.5 13.0
Standard Deviation (Risk)

Expected Return Expected Return

6.0 9.0
MSCI Health & Personal Care TR
5.5 8.0
MSCI Electrical & Electronics TR
7.0 MSCI Energy Sources TR
5.0 MSCI Recreation, Cons Goods TR MSCI Financial Services TR
6.0
4.5 MSCI Business & Public Serv TR
MSCI Insurance TR
5.0
MSCI Food & Hshold Prod TR
4.0 MSCI Business & Public Serv TR MSCI Chemicals TR 4.0 MSCI Real Estate TR
MSCI Telecomm TR MSCI Automobiles TR
MSCI Indust Components TR MSCI Real Estate TR 3.0
3.5 MSCI Recreation, Cons Goods TR
2.0 MSCI Chemicals TR MSCI Leisure & Tourism TR
3.0 MSCI Automobiles TR MSCI Leisure & Tourism TR

MSCI Health & Personal Care TR 1.0 MSCI Indust Components TR

2.5 MSCI Machinery & Engineering TR MSCI Utilities - Elec&Gas TR MSCI Broadcast & Publish TR
MSCI Banking TR
0.0 MSCI Building Mat & Construct TR
MSCI Forest ProdMisc
MSCI & Paper TR
Materials&Commod TR
2.0 MSCI Energy Sources TR
-1.0

1.5 MSCI Electrical & Electronics TR

-2.0
MSCI Misc Materials&Commod TR
MSCI Food & Hshold Prod TR -3.0
1.0 MSCI Forest Prod & Paper TR MSCI Machinery & Engineering TR
-4.0
0.5 MSCI Financial Services TR
MSCI Transport - Road&Rail TR -5.0 MSCI Transport - Road&Rail TR
MSCI Building Mat & Construct TR
0.0 MSCI Broadcast & Publish TR
MSCI Utilities - Elec&Gas TR -6.0
-0.5 MSCI Banking TR MSCI Construct & Housing TR
-7.0

-1.0 MSCI Insurance TR -8.0

-9.0
-1.5 MSCI Telecomm TR
-10.0
-2.0 MSCI Construct & Housing TR
-11.0
-2.5
-12.0

-3.0 -13.0

0.0 0.3 0.6 0.9 1.2 1.5 1.8 2.1 2.4 2.7 3.0 3.3 3.6 3.9 4.2 4.5 4.8 5.1 5.4 5.7 6.0 6.3 6.6 6.9 7.2 7.5 7.8 8.1 8.4 8.7 9.0 -14.0
Standard Deviation (Risk)
0.0 0.3 0.6 0.9 1.2 1.5 1.8 2.1 2.4 2.7 3.0 3.3 3.6 3.9 4.2 4.5 4.8 5.1 5.4 5.7 6.0 6.3 6.6 6.9 7.2 7.5 7.8 8.1 8.4 8.7 9.0
Standard Deviation (Risk)

Expected Return Expected Return

15.0 10.0
9.0 MSCI Broadcast & Publish TR
14.0 MSCI Telecomm TR MSCI Insurance TR
MSCI Electrical & Electronics TR 8.0
13.0 7.0 MSCI Health & Personal Care TR
MSCI Health & Personal Care TR
12.0 6.0 MSCI Utilities - Elec&Gas TR
MSCI Insurance TR 5.0 MSCI Financial Services TR
11.0 MSCI Business & Public Serv TR
MSCI Financial Services TR 4.0 MSCI Leisure & Tourism TR
MSCI Food & Hshold Prod TR
10.0 3.0
MSCI Banking TR
2.0
9.0 MSCI Business & Public Serv TR MSCI Banking TR
MSCI Food & Hshold Prod TR 1.0
8.0 MSCI Forest Prod & Paper TR MSCI Energy Sources TR
MSCI Energy Sources TR 0.0
MSCI Chemicals TR -1.0
MSCI Electrical & Electronics TR
7.0 MSCI Indust Components TR
MSCI Telecomm TR -2.0 MSCI Indust Components TR MSCI Automobiles TR
6.0 MSCI Automobiles TR MSCI Chemicals TR
-3.0
MSCI Machinery & Engineering TR MSCI Recreation, Cons Goods TR
5.0 MSCI Broadcast & Publish TR -4.0 MSCI Transport - Road&Rail TR MSCI Forest Prod & Paper TR
MSCI Transport - Road&Rail TR
4.0 -5.0
MSCI Leisure & Tourism TR -6.0 MSCI Misc Materials&Commod TR
3.0 MSCI Real Estate TR MSCI Building Mat & Construct TR
MSCI Recreation, Cons Goods TR -7.0
2.0 -8.0
MSCI Utilities - Elec&Gas TR
-9.0 MSCI Construct & Housing TR
1.0 MSCI Machinery & Engineering TR
MSCI Building Mat Misc
& Construct TR -10.0
MSCI Materials&Commod TR
0.0
-11.0
-1.0 -12.0
-13.0
-2.0
-14.0 MSCI Real Estate TR
-3.0 -15.0
-4.0 -16.0
-17.0
-5.0
MSCI Construct & Housing TR -18.0
-6.0 -19.0
-7.0 -20.0

-8.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0
Standard Deviation (Risk)
-9.0

0.0 0.4 0.8 1.2 1.6 2.0 2.4 2.8 3.2 3.6 4.0 4.4 4.8 5.2 5.6 6.0 6.4 6.8 7.2 7.6 8.0 8.4 8.8 9.2 9.6 10.0 10.4 11.0
Standard Deviation (Risk)
 Expected Return
Expected Return
14.0
20.0
13.0 MSCI Telecomm TR
18.0
12.0
MSCI Electrical & Electronics TR
16.0 11.0
10.0 MSCI Business & Public Serv TR
14.0
MSCI Telecomm TR
9.0 MSCI Broadcast & Publish TR
12.0
MSCI Insurance TR 8.0

10.0 MSCI Broadcast & Publish TR MSCI Business & Public Serv TR 7.0
MSCI Health & Personal Care TR
6.0 MSCI Health & Personal Care TR MSCI Electrical & Electronics TR
8.0
MSCI Financial Services TR 5.0
MSCI Automobiles TRMSCI Banking TR MSCI Construct & Housing TR
6.0 MSCI Recreation, Cons Goods TR MSCI Building Mat & Construct TR 4.0
MSCI Leisure & Tourism TR
MSCI Chemicals TR MSCI Transport - Road&Rail TR MSCI Real Estate TR
4.0 3.0 MSCI Insurance TR
MSCI Food & Hshold Prod TR MSCI Utilities - Elec&Gas TR MSCI Construct & Housing TR MSCI Financial Services TR
2.0
2.0 MSCI Utilities - Elec&Gas MSCI Energy Sources TR
TR Components
MSCI Indust TR
1.0 MSCI Automobiles TR
MSCI Machinery & Engineering TR MSCI Forest Prod & Paper TR
0.0
0.0
MSCI Food & Hshold Prod TR
-2.0 -1.0 MSCI Leisure
MSCI Indust Components TR & Tourism TR
MSCITR Misc Materials&Commod TR MSCI Forest Prod
MSCI Transport - Road&Rail -2.0 MSCI Building Mat & Construct TR & Paper TR
-4.0
-3.0 MSCI Banking TR
MSCI Energy Sources TR
MSCI Recreation, Cons Goods TR
-6.0 -4.0 MSCI Machinery & Engineering TR
MSCI Misc Materials&Commod TR
-8.0 -5.0
-6.0
-10.0 MSCI Real Estate TR
-7.0
MSCI Chemicals TR
-12.0 -8.0

-14.0 -9.0

-10.0
-16.0
-11.0
-18.0
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0 21.0 22.0 23.0
Standard Deviation (Risk)
-20.0

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 12.5 13.0 13.5 14.0
Standard Deviation (Risk)

Expected Return
16.0
15.0
MSCI Electrical & Electronics TR
14.0

13.0
12.0

11.0 MSCI Misc Materials&Commod TR MSCI Forest Prod & Paper TR

10.0 MSCI Financial Services TR

MSCI Broadcast & Publish TR
9.0
MSCI Recreation, Cons Goods TR
8.0 MSCI Real Estate TR MSCI Machinery & Engineering TR
MSCI Indust Components TR MSCI Energy Sources TR
7.0
MSCI Telecomm TR
6.0 MSCI Chemicals TR
MSCI Business & Public Serv TR
5.0
MSCI Building Mat & Construct TR
4.0 MSCI Banking TR
MSCI Leisure & Tourism TR
3.0
MSCI Construct & Housing TR MSCI Automobiles TR
2.0
1.0 MSCI Transport - Road&Rail TR

0.0

-1.0

-2.0
MSCI Health & Personal Care TR
-3.0
MSCI Utilities - Elec&Gas TR
-4.0
MSCI Food & Hshold
MSCIProd
Insurance
TR TR
-5.0
-6.0

-7.0
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0
Standard Deviation (Risk)

24
Appendix B – Short-term (6 months) holding period efficient frontiers (MSCI
countries)

Expected Return
7.0
6.5 MSCI Finland TR
Expected Return
8.0 6.0
7.5 5.5 MSCI Norway TR
MSCI Finland TR
7.0 MSCI Italy TR 5.0
6.5 4.5 MSCI Ireland TR
6.0
4.0
5.5
3.5 MSCI Sweden TR
5.0 MSCI Japan TR MSCI U.S. TR
4.5 3.0 MSCI Netherlands TR
4.0 2.5
3.5 2.0
MSCI Norway TR MSCI U.K. TR MSCI New Zealand TR
3.0 1.5 MSCI Canada TR
2.5 1.0
MSCI World TR MSCI Portugal TR
2.0 MSCI Sweden TR MSCI Italy TR
0.5 MSCI World TR
1.5 MSCI Denmark TR MSCI Germany TR
0.0 MSCI Belgium TR
1.0 MSCI Ireland TR
-0.5 MSCI Singapore TR
0.5 MSCI U.S. TR
MSCI Belgium TRMSCI Canada TR MSCI Switzerland TR
0.0 -1.0 MSCI Spain TR
MSCI Netherlands TR MSCI Australia TR MSCI France TR
-0.5 MSCI New Zealand TR -1.5 MSCI Denmark TR
MSCI Australia TR
-1.0 -2.0
-1.5 MSCI Spain TR
MSCI Germany TR -2.5
-2.0 MSCI France TR MSCI Portugal TR -3.0
-2.5
MSCI U.K. TR -3.5
-3.0
MSCI Singapore TR -4.0
-3.5
-4.0 MSCI Switzerland TR -4.5
-4.5 MSCI Austria TR MSCI Japan TR
-5.0
-5.0 -5.5
-5.5 -6.0 MSCI Austria TR
-6.0
-6.5
-6.5
-7.0 -7.0
-7.5 MSCI Hong Kong TR
-7.5
-8.0 MSCI Hong Kong TR -8.0
-8.5 -8.5
-9.0 -9.0
-9.5 -9.5
-10.0
-10.0
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 12.5 13.0
Standard Deviation (Risk)
Standard Deviation (Risk)

Expected Return
11.0
MSCI Finland TR
Expected Return
10.0
15.0
MSCI U.S. TR
9.0 14.0 MSCI Japan TR
13.0
8.0 MSCI Sweden TR
12.0
7.0 MSCI New Zealand TR
11.0
MSCI World TR
MSCI Australia TR
6.0 MSCI Hong Kong TR 10.0
MSCI Canada TR
MSCI U.K. TR 9.0
5.0 MSCIMSCI
Belgium TR
Netherlands TR MSCI Hong Kong TR
MSCI Netherlands TR MSCI U.S. TR MSCI Spain TR
8.0
MSCI Spain TR
4.0 MSCI Ireland TR
MSCI Belgium TR MSCI Switzerland TR 7.0
MSCI Denmark TR
3.0 MSCI Germany TR 6.0 MSCI Switzerland TR MSCI Germany TR
MSCI U.K. TR MSCI World TR
MSCI France TR 5.0 MSCI Ireland TR MSCI Canada TR
MSCI Singapore TR
2.0 MSCI Denmark TR
MSCI Italy TR 4.0 MSCI Australia TR MSCI France TR
MSCI Portugal TR
1.0
3.0
MSCI Norway TR MSCI Sweden TR
0.0 2.0
MSCI Singapore TR MSCI New Zealand TR MSCI Italy TR
-1.0 MSCI Austria TR 1.0
MSCI Norway TR MSCI Austria TR
MSCI Portugal TR
0.0
-2.0
-1.0
-3.0 -2.0

-4.0 -3.0

-4.0
-5.0 MSCI Japan TR
-5.0
-6.0
-6.0 MSCI Finland TR
-7.0 -7.0

-8.0
-8.0
-9.0
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0
Standard Deviation (Risk) 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0
Standard Deviation (Risk)

Expected Return
Expected Return 20.0
11.0
10.5 18.0
MSCI Portugal TR MSCI Finland TR
10.0
16.0
9.5
9.0 14.0
8.5 MSCI Spain TR
MSCI Denmark TR MSCI Sweden TR
8.0 12.0
7.5
10.0 MSCI Netherlands TR MSCI Portugal TR
7.0 MSCI Norway TR
6.5 MSCI Belgium TR MSCI U.S. TR
MSCI Netherlands TR 8.0 MSCI U.K. TR MSCI Canada TR
MSCI Germany TR
6.0 MSCI Spain TR MSCI France TR
5.5
MSCI Ireland TR 6.0 MSCI Ireland TR MSCI Italy TR
5.0 MSCI New Zealand TR MSCI Switzerland
MSCI Hong Kong TR
TR
MSCI France TR
4.5 4.0 MSCI World TR
4.0 MSCI Belgium TR MSCI Australia TR
MSCIMSCI
Sweden TR TR
Germany MSCI Finland TR
3.5 MSCI Denmark TR 2.0
3.0 MSCI Austria TR
MSCI Canada TR MSCI Hong Kong TR
2.5 MSCI Norway TR 0.0 MSCI Singapore TR
2.0 MSCI U.S. TR MSCI Switzerland TR
MSCI World TR MSCI Austria TR
1.5 -2.0
1.0 MSCI U.K. TR
MSCI Italy TR -4.0
0.5 MSCI New Zealand TR MSCI Japan TR
0.0 -6.0
-0.5 MSCI Australia TR
MSCI Japan TR
-1.0 -8.0
-1.5
-2.0 -10.0
-2.5
-3.0 -12.0
-3.5
-14.0
-4.0
-4.5 MSCI Singapore TR
-16.0
-5.0
-5.5 -18.0
-6.0
-6.5 -20.0
-7.0
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 12.5 13.0 Standard Deviation (Risk)
Standard Deviation (Risk)

Expected Return Expected Return

30.0 20.0
18.0
28.0
16.0
26.0 MSCI Italy TR
14.0
MSCI Portugal TR
24.0 12.0
MSCI Portugal TR MSCI Ireland TR MSCI Denmark TR
10.0
22.0 MSCI U.K. TR
8.0 MSCI Switzerland TR
20.0 MSCI Netherlands TR MSCI Finland TR MSCI Austria TR
6.0 MSCI U.S. TR MSCI Belgium TR MSCI Spain TR
MSCI Germany TR MSCI France TR
MSCI Switzerland TR MSCI Germany TR MSCI Finland TR
18.0 MSCI Denmark TR 4.0 MSCI Canada TR
MSCI World TR MSCI Netherlands TR
16.0 2.0
MSCI Sweden TR
MSCI Belgium TR MSCI Sweden TR 0.0 MSCI Australia TR
MSCI Italy TR MSCI Norway TR
14.0
MSCI Spain TR -2.0 MSCI New Zealand TR
MSCI Ireland TR
12.0 MSCI France TR -4.0
MSCI U.S. TR
10.0 MSCI Norway TR -6.0 MSCI Japan TR
MSCI Austria TR -8.0
8.0 MSCI World TR MSCI Canada TR -10.0
MSCI U.K. TR MSCI Singapore TR
6.0 MSCI Hong Kong TR
-12.0
MSCI Australia TR MSCI New Zealand TR
4.0 -14.0
MSCI Japan TR -16.0
2.0
-18.0
MSCI Hong Kong TR
0.0
-20.0
MSCI Singapore TR
-2.0 -22.0

-4.0 -24.0
-26.0
-6.0
-28.0
-8.0 -30.0
-10.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0 21.0
Standard Deviation (Risk)
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0
Standard Deviation (Risk)

25
 Expected Return
20.0
Expected Return
30.0 18.0
MSCI Finland TR
28.0 16.0
26.0 MSCI Finland TR
14.0
24.0
22.0 12.0
20.0 10.0 MSCI Singapore TR
18.0 MSCI Spain TR
MSCI Belgium TR MSCI Hong Kong TR
MSCI Italy TR 8.0
16.0 MSCI Germany TR MSCI U.S. TR
14.0 MSCI Switzerland TRMSCI France TR MSCI Portugal TR 6.0
12.0 MSCI World TR
MSCI Austria TR
4.0
MSCI Sweden TR MSCI Australia TR
10.0 MSCI Ireland TR MSCI
MSCI Belgium TR NewItaly
MSCI Zealand
TR TR
MSCI Ireland TR 2.0
8.0 MSCI U.S. TR MSCI U.K. TR
MSCI Netherlands TR MSCI France TR
0.0 MSCI Spain TR
MSCI Portugal TR
6.0 MSCI World TR
MSCI Canada TR
4.0 MSCI U.K. TR MSCI Denmark TR MSCI Switzerland TR
-2.0 MSCI Germany TR
2.0
MSCI Australia TR
MSCI Canada MSCI
TR MSCIMSCI
JapanDenmark
TR MSCI Sweden TR
MSCI Japan TR Norway TR TR
-4.0 MSCI Netherlands TR
0.0 MSCI New Zealand TR
-2.0 -6.0
-4.0
-8.0
-6.0 MSCI Norway TR
-10.0
-8.0

-10.0 -12.0 MSCI Austria TR

-12.0
MSCI Singapore TR -14.0
-14.0 MSCI Hong Kong TR

-16.0
-16.0

-18.0 -18.0
-20.0
-20.0
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0
Standard Deviation (Risk) 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 20.0 22.0 24.0 26.0 29.0
Standard Deviation (Risk)

Expected Return
30.0

28.0 MSCI Singapore TR

26.0

24.0

22.0

20.0 MSCI Finland TR

18.0

16.0

14.0 MSCI Hong Kong TR

MSCI Japan TR
12.0
MSCI Sweden TR
10.0

8.0 MSCI France TR

MSCI U.S. TR
6.0 MSCI Canada TR MSCI Norway TR

MSCI Netherlands TR MSCI Austria TR

4.0
MSCI
MSCI World
U.K. TRTR MSCI Germany TR
MSCI Spain TR MSCI New Zealand TR
2.0 MSCI Australia TR
MSCI Ireland TR
MSCI Italy TR MSCI Denmark TR
0.0 MSCI Switzerland TR

-2.0
MSCI Portugal TR
MSCI Belgium TR
-4.0

-6.0

-8.0

-10.0

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0 21.0 22.0 23.0
Standard Deviation (Risk)

26
 Appendix C – Correlation Candlestick
Figure 7 –Up-up correlation candlestick (MSCI countries)

100.00%

80.00%

60.00%

40.00%

20.00%

0.00%
AUS AUT BEL CAN DEN FIN FRA GER HOK IRE ITA JAP NET NEZ NOR POR SIN SPA SWE SWI UK USA

-20.00%

-40.00%

-60.00%

-80.00%

-100.00%

Figure 8 – Down-down correlation candlestick (MSCI countries)

100.00%

80.00%

60.00%

40.00%

20.00%

0.00%
AUS AUT BEL CAN DEN FIN FRA GER HOK IRE ITA JAP NET NEZ NOR POR SIN SPA SWE SWI UK USA

-20.00%

-40.00%

-60.00%

-80.00%

-100.00%

27
Figure 9 – Mixed correlation candlestick (MSCI countries)

100.00%

80.00%

60.00%

40.00%

20.00%

0.00%
AUS AUT BEL CAN DEN FIN FRA GER HOK IRE ITA JAP NET NEZ NOR POR SIN SPA SWE SWI UK USA

-20.00%

-40.00%

-60.00%

-80.00%

-100.00%

Figure 10 –Up-up correlation candlestick (MSCI sectors)

100.00%

80.00%

60.00%

40.00%

20.00%

0.00%
ENE MAT CAP COM TRA AUT CON HOT MED RET FOO BEV HOU HEA PHA BAN FIN INS RES SOF TEC TEL UTI

-20.00%

-40.00%

-60.00%

-80.00%

-100.00%

28
 Figure 11 – Down-down correlation candlestick (MSCI sectors)
100.00%

80.00%

60.00%

40.00%

20.00%

0.00%
ENE MAT CAP COM TRA AUT CON HOT MED RET FOO BEV HOU HEA PHA BAN FIN INS RES SOF TEC TEL UTI

-20.00%

-40.00%

-60.00%

-80.00%

-100.00%

Figure 12 – Mixed correlation candlestick (MSCI sectors)

100.00%

80.00%

60.00%

40.00%

20.00%

0.00%
ENE MAT CAP COM TRA AUT CON HOT MED RET FOO BEV HOU HEA PHA BAN FIN INS RES SOF TEC TEL UTI

-20.00%

-40.00%

-60.00%

-80.00%

-100.00%

29
Appendix D – Generalization sets MSCI sectors

Out-of-sample returns - MSCI ENERGY Out-of-sample returns - MSCI MATERIAL

0.35 0.25

0.3 0.2

0.25
0.15

0.2
0.1

0.15
0.05

0.1
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
0.05
-0.05
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
-0.1
-0.05

-0.15
-0.1

-0.2
-0.15

-0.25
-0.2
MATERIAL NEURAL NET
ENERGY NEURAL NET

Out-of-sample returns - MSCI CAPITAL GOODS Out-of-sample returns - MSCI COMML SVC & SUPPL
0.3 0.2

0.25

0.15
0.2

0.15
0.1

0.1

0.05 0.05

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
0
-0.05 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

-0.1
-0.05

-0.15

-0.2 -0.1

CAPITAL GOODS NEURAL NET COMML SVC & SUPPL NEURAL NET

Out-of-sample returns - MSCI TRANSPORTATION Out-of-sample returns - MSCI AUTO COMPONENTS

0.25 0.25

0.2
0.2

0.15
0.15

0.1
0.1

0.05
0.05
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
0
-0.05 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

-0.05
-0.1

-0.15 -0.1

-0.2 -0.15

-0.25 -0.2

TRANSPORTATION NEURAL NET AUTO & COMPONENTS NEURAL NET

Out-of-sample returns - MSCI CONS DUR & APPAREL Out-of-sample returns - MSCI HOTELS RESTAURANTS AND LEISURE
0.3 0.25

0.25 0.2

0.2
0.15

0.15
0.1

0.1
0.05

0.05
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
-0.05
-0.05

-0.1
-0.1

-0.15
-0.15

-0.2
-0.2
HOTELS REST & LEIS NEURAL NET
CONS DUR & APPAREL NEURAL NET

30
 Out-of-sample returns - MSCI MEDIA
Out-of-sample returns - MSCI RETAILING
0.6
0.4

0.5

0.3
0.4

0.2
0.3

0.2 0.1

0.1
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
-0.1
-0.1

-0.2 -0.2

-0.3
-0.3
MEDIA NEURAL NET
RETAILING NEURAL NET

Out-of-sample returns - MSCI FOOD & DRUG Out-of-sample returns - MSCI FOOD BEV & TOBACCO
0.3 0.2

0.15

0.2
0.1

0.05
0.1

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

0 -0.05
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
-0.1

-0.1
-0.15

-0.2
-0.2
-0.25

-0.3
-0.3
FOOD BEV & TOBACCO NEURAL NET
FOOD & DRUG RETL NEURAL NET

Out-of-sample returns - MSCI HOUSE Out-of-sample returns - MSCI HEALTH CARE

0.3 0.3

0.2 0.2

0.1 0.1

0
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

-0.1
-0.1

-0.2
-0.2

-0.3
-0.3
H CARE EQUIP & SVC NEURAL NET
HOUSE & PERS PROD NEURAL NET

Out-of-sample returns - MSCI PHARMA & BIOTECH Out-of-sample returns - MSCI BANKS
0.4
0.35

0.3
0.3

0.25

0.2
0.2

0.15 0.1

0.1
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
0.05

0 -0.1
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

-0.05
-0.2

-0.1

-0.3
-0.15
BANKS NEURAL NET
PHARMA & BIOTECH NEURAL NET

31
 Out-of-sample returns - MSCI DIVERS FINANCIAL Out-of-sample returns - MSCI INSURANCE
0.3 0.35

0.3
0.25

0.25

0.2
0.2

0.15 0.15

0.1
0.1

0.05
0.05
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
0
-0.05
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

-0.05 -0.1

-0.15
-0.1
INSURANCE NEURAL NET
DIVERS FINANC NEURAL NET

Out-of-sample returns - MSCI SOFTWARE Out-of-sample returns - MSCI TECH HARD & EQUIPMENT
0.8 0.8

0.6 0.6

0.4 0.4

0.2
0.2

0
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

-0.2
-0.2

-0.4
-0.4

-0.6
-0.6
TECH HARD & EQUIP NEURAL NET
SOFTWARE & SERVICES NEURAL NET

Out-of-sample returns - MSCI TELECOM Out-of-sample returns - MSCI UTILITIES

0.5 0.2

0.4
0.15

0.3
0.1

0.2

0.05
0.1

0 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

-0.1
-0.05

-0.2
-0.1

-0.3

-0.15
-0.4
UTILITIES NEURAL NET
TELECOM SVC NEURAL NET

32
Appendix E – Generalization sets MSCI countries
Out-of-sample returns - MSCI AUSTRALIA Out-of-sample returns - MSCI AUSTRIA
0.2 0.5

0.4
0.15

0.3

0.1
0.2

0.05
0.1

0 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

-0.1
-0.05

-0.2

-0.1
-0.3

-0.15 -0.4

AUSTRALIA NEURAL NET AUSTRIA NEURAL NET

Out-of-sample returns - MSCI BELGIUM Out-of-sample returns - MSCI CANADA

0.4 0.7

0.6

0.3
0.5

0.2 0.4

0.3

0.1
0.2

0 0.1
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
-0.1
-0.1

-0.2
-0.2
CANADA NEURAL NET
BELGIUM NEURAL NET

Out-of-sample returns - MSCI DENMARK Out-of-sample returns - MSCI FINLAND

0.4 1.6

1.4

0.3
1.2

1
0.2

0.8

0.1 0.6

0.4

0
0.2
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

0
-0.1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

-0.2

-0.4
-0.2
FINLAND NEURAL NET
DENMARK NEURAL NET

Out-of-sample returns - MSCI FRANCE Out-of-sample returns - MSCI GERMANY

0.5 0.6

0.5
0.4

0.4
0.3

0.3

0.2

0.2

0.1
0.1

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

-0.1 -0.1

-0.2 -0.2

FRANCE NEURAL NET GERMANY NEURAL NET

33
 Out-of-sample returns - MSCI HONG KONG Out-of-sample returns - MSCI IRELAND
0.5 0.6

0.4
0.5

0.3
0.4

0.2

0.3
0.1

0 0.2
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

-0.1 0.1

-0.2
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
-0.3

-0.1
-0.4

-0.2
-0.5
IRELAND NEURAL NET
HONG KONG NEURAL NET

Out-of-sample returns - MSCI ITALY Out-of-sample returns - MSCI JAPAN

0.7 0.4

0.6
0.3

0.5

0.2
0.4

0.1
0.3

0.2
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

0.1
-0.1

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
-0.2
-0.1

-0.2 -0.3

ITALY NEURAL NET JAPAN NEURAL NET

Out-of-sample returns - MSCI NETHERLANDS Out-of-sample returns - MSCI NEW ZEALAND

0.6 0.2

0.5 0.15

0.4 0.1

0.3 0.05

0.2 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

0.1 -0.05

-0.1
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

-0.15
-0.1

-0.2
-0.2
NEW ZEALAND NEURAL NET
NETHERLANDS NEURAL NET

Out-of-sample returns - MSCI NORWAY Out-of-sample returns - MSCI PORTUGAL

0.3 0.7

0.6
0.2
0.5

0.1 0.4

0.3
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
0.2

-0.1
0.1

0
-0.2
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

-0.1

-0.3
-0.2

-0.3
-0.4
PORTUGAL NEURAL NET
NORWAY NEURAL NET

34
 Out-of-sample returns - MSCI SINGAPORE Out-of-sample returns - MSCI SPAIN
0.8 0.7

0.7 0.6

0.6
0.5

0.5
0.4
0.4

0.3
0.3

0.2 0.2

0.1 0.1

0
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
-0.1
-0.1

-0.2

-0.2
-0.3
SPAIN NEURAL NET
SINGAPORE NEURAL NET

Out-of-sample returns - MSCI SWITZERLAND Out-of-sample returns - MSCI UNITED KINGDOM

0.6 0.3

0.5 0.25

0.4 0.2

0.3 0.15

0.2 0.1

0.1 0.05

0 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

-0.1 -0.05

-0.2 -0.1

SWITZERLAND NEURAL NET UNITED KINGDOM NEURAL NET

Out-of-sample returns - MSCI USA Out-of-sample returns - MSCI WORLD

0.3 0.25

0.25 0.2

0.2
0.15

0.15
0.1

0.1
0.05

0.05

0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35
-0.05
-0.05

-0.1
-0.1

-0.15 -0.15

WORLD NEURAL NET

USA NEURAL NET

35