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Dynamic Portfolio Allocation in High Dimensions using Sparse Risk Factors

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  • Bruno P. C. Levy
  • Hedibert F. Lopes

Abstract

We propose a fast and flexible method to scale multivariate return volatility predictions up to high-dimensions using a dynamic risk factor model. Our approach increases parsimony via time-varying sparsity on factor loadings and is able to sequentially learn the use of constant or time-varying parameters and volatilities. We show in a dynamic portfolio allocation problem with 452 stocks from the S&P 500 index that our dynamic risk factor model is able to produce more stable and sparse predictions, achieving not just considerable portfolio performance improvements but also higher utility gains for the mean-variance investor compared to the traditional Wishart benchmark and the passive investment on the market index.

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  • Bruno P. C. Levy & Hedibert F. Lopes, 2021. "Dynamic Portfolio Allocation in High Dimensions using Sparse Risk Factors," Papers 2105.06584, arXiv.org, revised Nov 2021.
    • Handle: RePEc:arx:papers:2105.06584
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    File URL: http://arxiv.org/pdf/2105.06584
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    Cited by:

    1. Chuting Sun & Qi Wu & Xing Yan, 2023. "Dynamic CVaR Portfolio Construction with Attention-Powered Generative Factor Learning," Papers 2301.07318, arXiv.org, revised Jan 2024.

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