Robust Portfolio Selection Using Sparse Estimation of Comoment Tensors

27 Pages Posted: 1 Oct 2019 Last revised: 6 Dec 2019

See all articles by Nathan Lassance

Nathan Lassance

Catholic University of Louvain (UCL), Louvain Finance (LFIN)

Frédéric D. Vrins

Louvain Finance Center (LFIN), UC Louvain; Center for Operations Research and Econometrics (CORE), UC Louvain

Date Written: December 5, 2019

Abstract

It is well known that estimation issues severely impact the performances of investment strategies. This becomes even more problematic when accounting for higher moments as the number of parameters to be estimated quickly explodes with the number of assets. In this paper, we address this issue by relying on specific factor models. Although useful to reduce the dimension of the problem, principal component analysis (PCA) is only a partial solution. In particular, it does not break the exponential law that links the number of parameters to the moment order. This issue is tackled by using a new robust portfolio-selection technique that relies on independent component analysis (ICA). By linearly projecting the asset returns onto a small set of maximally independent factors, we obtain a sparse approximation of the comoment tensors of asset returns. This drastically decreases the dimensionality of the problem and, as expected, leads to well-performing, robust and low-turnover investment strategies.

Keywords: portfolio selection, robustness, independent component analysis, higher moments

JEL Classification: G11

Suggested Citation

Lassance, Nathan and Vrins, Frederic Daniel, Robust Portfolio Selection Using Sparse Estimation of Comoment Tensors (December 5, 2019). Available at SSRN: https://ssrn.com/abstract=3455400 or http://dx.doi.org/10.2139/ssrn.3455400

Nathan Lassance (Contact Author)

Catholic University of Louvain (UCL), Louvain Finance (LFIN) ( email )

Belgium

Frederic Daniel Vrins

Louvain Finance Center (LFIN), UC Louvain ( email )

Voie du Roman Pays 34
Louvain-la-Neuve, 1348
Belgium

HOME PAGE: http://www.uclouvain.be/frederic.vrins

Center for Operations Research and Econometrics (CORE), UC Louvain ( email )

Voie du Roman Pays 34
Louvain-la-Neuve,, B-1348
Belgium

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