Empirical Asset Pricing via Machine Learning

79 Pages Posted: 9 Apr 2018 Last revised: 15 Sep 2019

See all articles by Shihao Gu

Shihao Gu

University of Chicago - Booth School of Business

Bryan T. Kelly

Yale SOM; AQR Capital Management, LLC; National Bureau of Economic Research (NBER)

Dacheng Xiu

University of Chicago - Booth School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: September 13, 2019

Abstract

We perform a comparative analysis of machine learning methods for the canonical problem of empirical asset pricing: measuring asset risk premia. We demonstrate large economic gains to investors using machine learning forecasts, in some cases doubling the performance of leading regression-based strategies from the literature. We identify the best performing methods (trees and neural networks) and trace their predictive gains to allowance of nonlinear predictor interactions that are missed by other methods. All methods agree on the same set of dominant predictive signals which includes variations on momentum, liquidity, and volatility. Improved risk premium measurement through machine learning simplifies the investigation into economic mechanisms of asset pricing and highlights the value of machine learning in financial innovation.

Keywords: Machine Learning, Big Data, Return Prediction, Cross-Section of Returns, Ridge Regression, (Group) Lasso, Elastic Net, Random Forest, Gradient Boosting, (Deep) Neural Networks, Fintech

JEL Classification: G10, G11, G14, C14, C11, C21, C22, C23, C58

Suggested Citation

Gu, Shihao and Kelly, Bryan T. and Xiu, Dacheng, Empirical Asset Pricing via Machine Learning (September 13, 2019). Chicago Booth Research Paper No. 18-04; 31st Australasian Finance and Banking Conference 2018; Yale ICF Working Paper No. 2018-09. Available at SSRN: https://ssrn.com/abstract=3159577 or http://dx.doi.org/10.2139/ssrn.3159577

Shihao Gu

University of Chicago - Booth School of Business ( email )

Chicago, IL
United States

Bryan T. Kelly

Yale SOM ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Dacheng Xiu (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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