A Sparse Learning Approach to Relative-Volatility-Managed Portfolio Selection
SIAM Journal on Financial Mathematics
36 Pages Posted: 29 May 2018 Last revised: 15 Jun 2021
Date Written: May 16, 2018
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: Suggested Citation