Clustering heterogeneous financial networks

Abstract

We develop a convex‐optimization clustering algorithm for heterogeneous financial networks, in the presence of arbitrary or even adversarial outliers. In the stochastic block model with heterogeneity parameters, we penalize nodes whose degree exhibit unusual behavior beyond inlier heterogeneity. We prove that under mild conditions, this method achieves exact recovery of the underlying clusters. In absence of any assumption on outliers, they are shown not to hinder the clustering of the inliers. We test the performance of the algorithm on semi‐synthetic heterogenous networks reconstructed to match aggregate data on the Korean financial sector. Our method allows for recovery of sub‐sectors with significantly lower error rates compared to existing algorithms. For overlapping portfolio networks, we uncover a clustering structure supporting diversification effects in investment management.