A Sparse Learning Approach to Relative-Volatility-Managed Portfolio Selection

28 Pages Posted: 29 May 2018 Last revised: 6 Dec 2019

See all articles by Chi Seng Pun

Chi Seng Pun

Nanyang Technological University (NTU) - School of Physical and Mathematical Sciences

Date Written: May 16, 2018

Abstract

This paper proposes a self-calibrated sparse learning approach for estimating a sparse target vector, which is a product of a precision matrix and a vector, and investigates its application to finance to provide an innovative construction of relative-volatility-managed portfolio (RVMP). The proposed iterative algorithm, called DECODE, jointly estimates a performance measure of the market and the effective parameter vector in the optimal portfolio solution, where the relative-volatility timing is introduced into the risk exposure of an efficient portfolio via the control of its sparsity. The portfolio's risk exposure level, which is linked to its sparsity in the proposed framework, is automatically tuned with the latest market condition without using cross-validation. The algorithm is efficient as it costs only a few computations of quadratic programming. We prove that the iterative algorithm converges and show the oracle inequalities of the DECODE, which provide sufficient conditions for a consistent estimate of an optimal portfolio. The algorithm can also handle the curse of dimensionality that the number of training samples is less than the number of assets. Our empirical studies of over-12-year backtest illustrate the relative-volatility timing feature of the DECODE and the superior out-of-sample performance of the DECODE strategy, which beats the equally-weighted strategy and improves over the shrinkage strategy.

Keywords: Direct Estimation, Iterative Algorithm, Self-Calibrated Regularization, Oracle Inequality, Relative-Volatility Timing, Market-Sensitive Asset Selection

JEL Classification: G11, C13, C16

Suggested Citation

Pun, Chi Seng, A Sparse Learning Approach to Relative-Volatility-Managed Portfolio Selection (May 16, 2018). Available at SSRN: https://ssrn.com/abstract=3179569 or http://dx.doi.org/10.2139/ssrn.3179569

Chi Seng Pun (Contact Author)

Nanyang Technological University (NTU) - School of Physical and Mathematical Sciences ( email )

SPMS-MAS-05-22
21 Nanyang Link
Singapore, 637371
Singapore
(+65) 6513 7468 (Phone)

HOME PAGE: http://personal.ntu.edu.sg/cspun/

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