Principal Component and Constantly Re-Balanced Portfolio - Slides

Principal component and constantly re-balanced
portfolio
György Ottucsák1
László Györfi
1 Departmentof Computer Science and Information Theory

Budapest University of Technology and Economics
Budapest, Hungary
September 20, 2007
e-mail: oti@szit.bme.hu
www.szit.bme.hu/õti
www.szit.bme.hu/õti/portfolio
Ottucsák, Györfi Principal component and constantly re-balanced portfolio
Investment in the stock market: Growth rate
The model:
d assets

The model:
d assets
(j)
Sn price of asset j at the end of trading period (day) n initial
(j)
price S0 = 1,

The model:
d assets
(j)
(j)
price S0 = 1,
(j)
(j)
Sn = e nWn j = 1, . . . , d
average growth rate
(j) 1 (j)
Wn = ln Sn
n

The model:
d assets
(j)
(j)
price S0 = 1,
(j) (j)
(j)
Sn = e nWn ≈ e nW j = 1, . . . , d
average growth rate
(j) 1 (j)
Wn = ln Sn
n
asymptotic average growth rate

1 (j)
W (j) = lim ln Sn
n→∞ n

Static portfolio selection: single period investment
The aim is to achieve maxj W (j) .


Static portfolio selection:
Fix a portfolio vector b = (b (1) , . . . b (d) ).
S0 b (j) denotes the proportion of the investor’s capital invested
in asset j. Assumptions:
no short-sales b (j) ≥ 0
self-financing j b (j) = 1
P


P
After n day
(j)
X
Sn = S0 b (j) Sn
j


P
After n day
(j)
X
Sn = S0 b (j) Sn
j
Use the following simple bound

(j) (j)
S0 max b (j) Sn ≤ Sn ≤ dS0 max b (j) Sn
j j

assume that b (j) > 0

1
(j) (j)
1 1 (j) (j)
ln max S0 b Sn ≤ ln Sn ≤ ln dS0 max b Sn
n j n n j


1
(j) (j)
1 1 (j) (j)
n j n n j

1 1 (j) 1
max ln S0 b (j) + ln Sn ≤ln Sn
j n n n

1 1 (j)
≤ max ln(dS0 b (j) ) + ln Sn
j n n


1
(j) (j)
1 1 (j) (j)
n j n n j

1 1 (j) 1
j n n n

1 1 (j)
j n n
1 1 (j)
lim ln Sn = lim max ln Sn = max W (j)
n→∞ n n→∞ j n j
Conclusion: any static portfolio achieves the maximal growth rate

maxj W (j) .


1
(j) (j)
1 1 (j) (j)
n j n n j

1 1 (j) 1
j n n n

1 1 (j)
j n n
1 1 (j)
lim ln Sn = lim max ln Sn = max W (j)
n→∞ n n→∞ j n j
Conclusion: any static portfolio achieves the maximal growth rate

maxj W (j) . We can do much better!

Dynamic portfolio selection: multi-period investment
The model:
(1) (d)
Let xi = (xi , . . . xi ) the return vector on trading period i,
where
(j)
(j) Si
xi = (j)
.
Si−1
is the price relatives of two consecutive days.

The model:
(1) (d)
where
(j)
(j) Si
xi = (j)
.
Si−1
(j)
xi is the factor by which capital invested in stock j grows during
the market period i

The model:
(1) (d)
where
(j)
(j) Si
xi = (j)
.
Si−1
(j)
the market period i
One of the simplest dynamic portfolio strategy is the
Constantly Re-balanced Portfolio (CRP):
Fix a portfolio vector b = (b (1) , . . . b (d) ), where b (j) gives the

proportion of the investor’s capital invested in stock j.

The model:
(1) (d)
where
(j)
(j) Si
xi = (j)
.
Si−1
(j)
the market period i
One of the simplest dynamic portfolio strategy is the
Constantly Re-balanced Portfolio (CRP):
Fix a portfolio vector b = (b (1) , . . . b (d) ), where b (j) gives the

proportion of the investor’s capital invested in stock j.
This b is the portfolio vector for each trading day.

Dynamic portfolio selection: multi-period investment:2
Repeatedly investment:
for the first trading period S0 denotes the initial capital
d
(j)
X
S1 = S0 b (j) x1 = S0 hb , x1 i
j=1

d
(j)
X
S1 = S0 b (j) x1 = S0 hb , x1 i
j=1
for the second trading period, S1 new initial capital

S2 = S1 · hb , x2 i = S0 · hb , x1 i · hb , x2 i .

d
(j)
X
S1 = S0 b (j) x1 = S0 hb , x1 i
j=1

for the nth trading period:

n
Y
Sn = Sn−1 hb , xn i = S0 hb , xi i
i=1

d
(j)
X
S1 = S0 b (j) x1 = S0 hb , x1 i
j=1

for the nth trading period:

n
Y
Sn = Sn−1 hb , xn i = S0 hb , xi i = S0 e nWn (b)
i=1
with the average growth rate
n
1X
Wn (b) = ln hb , xi i .
n
i=1
log-optimum portfolio
The CRP is the optimal portfolio for special market process, where
X1 , X2 , . . . is independent and identically distributed (i.i.d.)
Log-optimum portfolio b∗
E{ln hb∗ , X1 i} = max E{ln hb , X1 i}

b


b
Best Constantly Re-balanced Portfolio (BCRP)


b

Properties:
needed full-knowledge on the distribution


b

Properties:
needed full-knowledge on the distribution
in experiments: not a causal strategy. We can calculate it
only in hindsight.

Optimality
If Sn∗ = Sn (b∗ ) denotes the capital after trading period n achieved

by a log-optimum portfolio strategy b∗ , then for any portfolio
strategy b with capital Sn = Sn (b) and for any i.i.d. process
{Xn }∞ −∞ ,
1 1
lim ln Sn ≤ lim ln Sn∗ almost surely
n→∞ n n→∞ n

Optimality
If Sn∗ = Sn (b∗ ) denotes the capital after trading period n achieved

by a log-optimum portfolio strategy b∗ , then for any portfolio
strategy b with capital Sn = Sn (b) and for any i.i.d. process
{Xn }∞ −∞ ,
1 1
lim ln Sn ≤ lim ln Sn∗ almost surely
n→∞ n n→∞ n
and
1
lim ln Sn∗ = W ∗ almost surely,
n→∞ n
where
W ∗ = E{ln hb∗ , X1 i}
is the maximal growth rate of any portfolio.

Semi-log-optimal portfolio
log-optimal:
arg max E{ln hb , X1 i}
b
It is a non-linear (convex) optimization problem with linear
constraints. Calculation: not cheap.

log-optimal:
b
Idea: use the Taylor expansion:
1
ln z ≈ h(z) = z − 1 − (z − 1)2
2
Only the two biggest principal components, others are drop.

log-optimal:
b
1
ln z ≈ h(z) = z − 1 − (z − 1)2
2
semi-log-optimal:
arg max E{h(hb , X1 i)}
b

log-optimal:
b
1
ln z ≈ h(z) = z − 1 − (z − 1)2
2
semi-log-optimal:
arg max E{h(hb , X1 i)} = arg max{hb , mi − hb , Cbi}
b b

log-optimal:
b
1
ln z ≈ h(z) = z − 1 − (z − 1)2
2
semi-log-optimal:
b b
Cheaper: Quadratic Programming (QP)

log-optimal:
b
1
ln z ≈ h(z) = z − 1 − (z − 1)2
2
semi-log-optimal:
b b
Connection to the Markowitz theory.

log-optimal:
b
1
ln z ≈ h(z) = z − 1 − (z − 1)2
2
semi-log-optimal:
b b
Connection to the Markowitz theory.
Gy. Ottucsák and I. Vajda, ”An Asymptotic Analysis of the
Mean-Variance portfolio selection”, Statistics&Decisions, 25, pp. 63-88,
2007. http://www.szit.bme.hu/õti/portfolio/articles/marko.pdf
Principal component
We may write
1
E{hb , X1 i − 1} − E{(hb , X1 i − 1)2 }
2

Principal component
We may write
1
E{hb , X1 i − 1} − E{(hb , X1 i − 1)2 }
2
1 3
= 2E{hb , X1 i} − E{hb , X1 i2 } −
2 2

Principal component
We may write
1
E{hb , X1 i − 1} − E{(hb , X1 i − 1)2 }
2
1 3
= 2E{hb , X1 i} − E{hb , X1 i2 } −
2 2
1 2 1
= − E{(hb , X1 i − 2) } +
2 2

Principal component
We may write
1
E{hb , X1 i − 1} − E{(hb , X1 i − 1)2 }
2
1 3
= 2E{hb , X1 i} − E{hb , X1 i2 } −
2 2
1 2 1
= − E{(hb , X1 i − 2) } +
2 2
then
1 1
arg max − E{(hb , X1 i − 2)2 } + =
b 2 2
arg min E{(hb , X1 i − 2)2 },
b
that is, we are looking for the portfolio which minimize the
expected squared error.
Conditions of the model:
Assume that
the assets are arbitrarily divisible,

Assume that
the assets are available in unbounded quantities at the current
price at any given trading period,

Assume that
there are no transaction costs,
(go to Session 1 today at 17.30)

Assume that
there are no transaction costs,
(go to Session 1 today at 17.30)
the behavior of the market is not affected by the actions of
the investor using the strategy under investigation.

NYSE data sets
At www.szit.bme.hu/~oti/portfolio there are two benchmark

data sets from NYSE:
The first data set consists of daily data of 36 stocks with
length 22 years.
The second data set contains 23 stocks and has length 44
years.
Both sets are corrected with the dividends.

NYSE data sets
At www.szit.bme.hu/~oti/portfolio there are two benchmark

data sets from NYSE:
The first data set consists of daily data of 36 stocks with
length 22 years.
The second data set contains 23 stocks and has length 44
years.
Both sets are corrected with the dividends.
Our experiment is on the second data set.

Experimental results on CRP
Stock’s name AAY BCRP

log-NLP weights semi-log-QP weights
COMME 18% 0.3028 0.2962
HP 15% 0.0100 0.0317
KINAR 4% 0.2175 0.2130
MORRIS 20% 0.4696 0.4590
AAY 24% 24%
running time (sec) 9002 3
Table: Comparison of the two algorithms for CRPs.


COMME 18% 0.3028 0.2962
HP 15% 0.0100 0.0317
KINAR 4% 0.2175 0.2130
MORRIS 20% 0.4696 0.4590
AAY 24% 24%
The other 19 assets have 0 weight


COMME 18% 0.3028 0.2962
HP 15% 0.0100 0.0317
KINAR 4% 0.2175 0.2130
MORRIS 20% 0.4696 0.4590
AAY 24% 24%
The other 19 assets have 0 weight
KINAR had the smallest AAY

Dynamic portfolio selection: Causal-CRP
BCRP is not a causal strategy. A simple causal version could be,

that we use the CRP that was optimal up to n − 1 for the next
(nth) day.
Stock’s name AAY BCRP CCRP Static

log-NLP w. semi-log-QP w.
COMME 18% 0.3028 0.2962
HP 15% 0.0100 0.0317
KINAR 4% 0.2175 0.2130
MORRIS 20% 0.4696 0.4590
AAY 24% 24% 14% 16%
running t. (sec) 9002 3 111 3

Dynamic portfolio selection: Causal-CRP
BCRP is not a causal strategy. A simple causal version could be,

that we use the CRP that was optimal up to n − 1 for the next
(nth) day.
Stock’s name AAY BCRP CCRP Static

log-NLP w. semi-log-QP w.
COMME 18% 0.3028 0.2962
HP 15% 0.0100 0.0317
KINAR 4% 0.2175 0.2130
MORRIS 20% 0.4696 0.4590
AAY 24% 24% 14% 16%
running t. (sec) 9002 3 111 3
we can even do much better!!

Dynamic portfolio selection: general case
(1) (d)
xi = (xi , . . . xi ) the return vector on day i
b = b1 is the portfolio vector for the first day
initial capital S0
S1 = S0 · hb1 , x1 i

(1) (d)
initial capital S0
S1 = S0 · hb1 , x1 i
for the second day, S1 new initial capital, the portfolio vector
b2 = b(x1 )
S2 = S0 · hb1 , x1 i · hb(x1 ) , x2 i .

(1) (d)
initial capital S0
S1 = S0 · hb1 , x1 i
b2 = b(x1 )
S2 = S0 · hb1 , x1 i · hb(x1 ) , x2 i .
nth day a portfolio strategy bn = b(x1 , . . . , xn−1 ) = b(xn−1
1 )
Yn D E
Sn = S0 b(xi−1
1 ) , xi =
i=1

(1) (d)
initial capital S0
S1 = S0 · hb1 , x1 i
b2 = b(x1 )
S2 = S0 · hb1 , x1 i · hb(x1 ) , x2 i .
nth day a portfolio strategy bn = b(x1 , . . . , xn−1 ) = b(xn−1
1 )
Yn D E
Sn = S0 b(xi−1
1 ) , xi = S0 e nWn (B)
i=1
with the average growth rate
n
1 X D i−1 E
Wn (B) = ln b(x1 ) , xi .
n
i=1

X1 , X2 , . . . drawn from the vector valued stationary and ergodic

process
log-optimum portfolio B∗ = {b∗ (·)}
E{ln b∗ (Xn−1 n−1 n−1 n−1

1 ) , Xn | X1 } = max E{ln b(X1 ) , Xn | X1 }
b(·)
Xn−1
1 = X1 , . . . , Xn−1

Optimality
Algoet and Cover (1988): If Sn∗ = Sn (B∗ ) denotes the capital after
day n achieved by a log-optimum portfolio strategy B∗ , then for
any portfolio strategy B with capital Sn = Sn (B) and for any
process {Xn }∞−∞ ,

1 1
lim sup ln Sn − ln Sn∗ ≤ 0 almost surely
n→∞ n n
for stationary ergodic process {Xn }∞

−∞ .

Kernel-based portfolio selection
fix integers k, ` = 1, 2, . . .
elementary portfolios
choose the radius rk,` > 0 such that for any fixed k,
lim rk,` = 0.
`→∞

Kernel-based portfolio selection
fix integers k, ` = 1, 2, . . .
elementary portfolios
choose the radius rk,` > 0 such that for any fixed k,
lim rk,` = 0.
`→∞
for n > k + 1, define the expert b(k,`) by

X
b(k,`) (xn−1
1 ) = arg max ln hb , xi i ,
b i−1 n−1
{k<i<n:kxi−k −xn−k k≤rk,` }
if the sum is non-void, and b0 = (1/d, . . . , 1/d) otherwise.

Combining elementary portfolios
let {qk,` } be a probability distribution on the set of all pairs (k, `)

such that for all k, `, qk,` > 0.

Combining elementary portfolios
let {qk,` } be a probability distribution on the set of all pairs (k, `)

such that for all k, `, qk,` > 0.
The strategy B is the combination of the elementary portfolio
(k,`)
strategies B(k,`) = {bn } such that the investor’s capital becomes
X
Sn (B) = qk,` Sn (B(k,`) ).
k,`

Experiments on average annual yields (AAY)
Kernel based log-optimal portfolio selection with

k = 1, . . . , 5 and ` = 1, . . . , 10
2
rk,` = 0.0001 · d · k · `,


k = 1, . . . , 5 and ` = 1, . . . , 10
2
rk,` = 0.0001 · d · k · `,
AAY of kernel based semi-log-optimal portfolio is 128%


k = 1, . . . , 5 and ` = 1, . . . , 10
2
rk,` = 0.0001 · d · k · `,
double the capital


k = 1, . . . , 5 and ` = 1, . . . , 10
2
rk,` = 0.0001 · d · k · `,
double the capital
MORRIS had the best AAY, 20%


k = 1, . . . , 5 and ` = 1, . . . , 10
2
rk,` = 0.0001 · d · k · `,
double the capital
MORRIS had the best AAY, 20%
the BCRP had average AAY 24%

The average annual yields of the individual experts.
k 1 2 3 4 5
`
1 20% 19% 16% 16% 16%
2 118% 77% 62% 24% 58%
3 71% 41% 26% 58% 21%
4 103% 94% 63% 97% 34%
5 134% 102% 100% 102% 67%
6 140% 125% 105% 108% 87%
7 148% 123% 107% 99% 96%
8 132% 112% 102% 85% 81%
9 127% 103% 98% 74% 72%
10 123% 92% 81% 65% 69%

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Principal component and constantly re-balanced

1 Departmentof Computer Science and Information Theory

September 20, 2007

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

asymptotic average growth rate

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

The aim is to achieve maxj W (j) .

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

The aim is to achieve maxj W (j) .

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

The aim is to achieve maxj W (j) .

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

The aim is to achieve maxj W (j) .

Use the following simple bound

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Conclusion: any static portfolio achieves the maximal growth rate

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Conclusion: any static portfolio achieves the maximal growth rate

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Fix a portfolio vector b = (b (1) , . . . b (d) ), where b (j) gives the

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Fix a portfolio vector b = (b (1) , . . . b (d) ), where b (j) gives the

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

for the second trading period, S1 new initial capital

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

for the second trading period, S1 new initial capital

for the nth trading period:

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

for the second trading period, S1 new initial capital

for the nth trading period:

E{ln hb∗ , X1 i} = max E{ln hb , X1 i}

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

E{ln hb∗ , X1 i} = max E{ln hb , X1 i}

Best Constantly Re-balanced Portfolio (BCRP)

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

E{ln hb∗ , X1 i} = max E{ln hb , X1 i}

Best Constantly Re-balanced Portfolio (BCRP)

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

E{ln hb∗ , X1 i} = max E{ln hb , X1 i}

Best Constantly Re-balanced Portfolio (BCRP)

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

If Sn∗ = Sn (b∗ ) denotes the capital after trading period n achieved

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

If Sn∗ = Sn (b∗ ) denotes the capital after trading period n achieved

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio

Ottucsák, Györfi Principal component and constantly re-balanced portfolio