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Empirical log-optimal portfolio selections: a survey.

Lszl Gyr

Gyrgy Ottucsk

Andrs Urbn

Department of Computer Science and Information Theory Budapest University of Technology and Economics, Magyar Tudsok krtja 2.,Budapest, Hungary, H-1117
{gyorfi,oti,urbi}@szit.bme.hu

Abstract
This paper provides a survey of discrete time, multi period, sequential investment strategies for nancial markets. Under memoryless assumption on the underlying process generating the asset prices the Best Constantly Rebalanced Portfolio is studied, called log-optimal portfolio, which achieves the maximal asymptotic average growth rate. Semi-log optimal portfolio selection as a small computational complexity alternative of the log-optimal portfolio selection is studied both theoretically and empirically. For generalized dynamic portfolio selection, when asset prices are generated by a stationary and ergodic process, universally consistent empirical methods are shown. Empirical portfolio selection methods are proposed to handle the proportional transaction cost. The empirical performance of the methods illustrated for NYSE data with and without transaction costs.

Institute of the Hungarian Academy of Sciences.

The rst author acknowledges the support of the Computer and Automation Research
I

Contents
1 Introduction
IFI IFP PFI PFP PFQ QFI QFP QFQ QFR QFS QFT QFU xottions F F F F F F F F F F F F F F F F F F F F F F F F F F F F F tti portfolio seletion F F F F F F F F F F F F F F F F F F F F F vogEoptiml portfolio for memoryless mrket proess F F F F F ixmples for onstntly relned portfolio F F F F F F F F F emiElogEoptiml portfolio F F F F F F F F F F F F F F F F F F F F vogEoptiml portfolio for sttionry mrket proess impiril portfolio seletion F F F F F F F F F F F F F egression funtion estimtion F F F F F F F F F F F ristogrm sed strtegy F F F F F F F F F F F F F F uernel sed strtegy F F F F F F F F F F F F F F F F xerest neighor sed strtegy F F F F F F F F F F F xumeril results on empiril portfolio seletion F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F F

2
Q R

2 Constantly rebalanced portfolio selection

T IH IV

3 Time varying portfolio selection

20
PI PQ PR PU PW QI QI

4 Portfolio selection with consumption 5 Portfolio selection for proportional transaction cost

36 41

Introduction

his pper gives n overview on the investment strtegies in (nnil stok mrkets inspired y the results of informtion theoryD nonEprmetri sttisE tis nd mhine lerningF snvestment strtegies re llowed to use informE tion olleted from the pst of the mrket nd determineD t the eginning of trding periodD portfolioD tht isD wy to distriute their urrent pE itl mong the ville ssetsF he gol of the investor is to mximize his welth in the long run without knowing the underlying distriution generE ting the stok priesF nder this ssumption the symptoti rte of growth hs wellEde(ned mximum whih n e hieved in full knowledge of the underlying distriution generted y the stok priesF foth stti @uy nd holdA nd dynmi @dily relningA portfolio seletions re onsidered under vrious ssumptions on the ehvior of the P

mrket proessF sn se of stti portfolio seletionD it ws shown tht every portfolio hieves the mximl growth rteF yne n hieve lrger growth rte with dily relningF nder memoryless ssumption on the underE lying proess generting the sset priesD the logEoptiml portfolio hieves the mximl symptoti verge growth rteD tht is the expeted vlue of the logrithm of the return for the est (x portfolio vetorF emiElog optiml portfolio seletion s smll omputtionl omplexity lterntive of the logEoptiml portfolio seletion is studied oth theoretilly nd emE pirillyF por generlized dynmi portfolio seletionD when sset pries re generted y sttionry nd ergodi proessD universl onsistent @empirE ilA methods tht hieve the mximl possile growth rte re shownF wo extensions of the empiril portfolio seletion methods re proposed to hndle the proportionl trnstion ostF he empiril performne of the methods illustrted for dt with nd without trnstion ostsF he rest of the pper is orgnized s followsF sn etion P the onE stntly relned portfolio is introduedD nd the properties of logEoptiml portfolio seletion is nlyzed in se of memoryless mrketF xextD smll omputtionl omplexity lterntive of the logEoptiml portfolio seletionD the semiElog optiml portfolio is introduedF sn etion Q the generl model of the dynmi portfolio seletion is introdued nd the si fetures of the logEoptiml portfolio seletion in se of sttionry nd ergodi mrket re summrizedF sing the priniples of nonprmetri sttistis nd mE hine lerningD universl onsistentD empiril investment strtegies tht re le to hieve the mximl symptoti growth rte re introduedF ixE periments on the dt re given in etion QFUF he possiility of onsumption n e inluded in the model @etion RAF sn etion S the portfolio seletion with proportionl trnstion osts is nlyzedF

NYSE

NYSE

1.1

Notations

gonsider mrket onsisting of d ssetsF he evolution of the mrket in time is represented y sequene of prie vetors sI ; sP ; : : : P Rd D where C

sn

a @s@IA; : : : ; s@ndAA n
@j A

suh tht the j Eth omponent sn of sn denotes the prie of the j Eth sset @j A on the nEth trding periodF sn order to normlizeD put sH F fsn g hs

aI

exponentil trendX

sn

( @j A a enWnj) % enW (j) ;

with verge growth rte @verge yieldA


Wn

@j A Xa

I ln s@njA

nd with symptoti verge growth rte


W @j A

I Xa nlim n ln s@njA: 3I

sn order to pply the usul predition tehniques for time series nlysis one hs to trnsform the sequene prie vetors fsn g into more or less sttionry sequene of return vetors fxn g s followsX

xn
suh tht

a @x@IA; : : : ; x@ndAA n
xn

@j A a

husD the j Eth omponent xn of the return vetor xn denotes the mount otined fter investing unit pitl in the j Eth sset on the nEth trding periodF
1.2 Static portfolio selection

@j A

@j A @j A : snI
sn

he stti portfolio seletion is single period investment strtegyF e portE folio vetor is denoted y b b@IA ; : : : b@dA F he j Eth omponent b@j A of b denotes the proportion of the investor9s pitl invested in sset j F e sE sume tht the portfolio vetor b hs nonnegtive omponents sum up to D tht mens tht short selling is not permittedF he set of portfolio vetors is denoted y

a@

d a

8 < :

a @b@IA; : : : ; b@dAAY b@jA ! H; aH


R

d X j

aI

b@j A

aI

9 = ;

he im of stti portfolio seletion is to hieve I j d W @j A F por stti portfolio seletionD t time n we distriute the initil pitl SH

mx

ording to (x portfolio vetor bD iFeFD if Sn denotes the welth t the trding period nD then
Sn

a SH

d X

aI

b@j A sn :

@j A

epply the following simple ounds


SH

mx b@jAs@njA j

Sn

dSH

mx b@jAs@njA: j

sf b@j A >

H for ll j a I; : : : ; d then these ounds imply tht I ln Sn a lim mx I ln s@njA a mx W @jA: W Xa lim
n

3I n

3I

husD ny stti portfolio seletion hieves the mximl growth rte

mxj W @jAF

Constantly rebalanced portfolio selection

yne n hieve even higher growth rte for long run investmentsD if the tuning of the porfolio is llowed dynamically fter eh trding periodF he dynmi portfolio seletion is multiEperiod investment strtegyD where t the eginning of eh trding period we rerrnge the welth mong the ssetsF en representtive exmple of the dynmi portfolio seletion is the onstntly relned portfolio @gAD ws introdued nd studied y uelly PVD vtn QHD freimn UD wrkowitz QQD pinkelstein nd hitley ISD wri QUD wri nd zkely RH nd frron nd gover SF por omprehensive survey see lso ghpters T nd IS in gover nd homs IPD nd ghpter IS in vuenerger QIF vuenerger QI summrizes the min onlusions s followsX 4gonlusions out multiperiod investment situtions re not mere vritions of singleEperiod onlusions ! rther they o'er reverse those erlier onlusionsF his mkes the sujet exitingD oth intelletully nd in prtieF yne the sutleties of multiperiod investment re understoodD the rewrd in terms of enhned investment performne n e sustntilF4 4portuntely the onepts nd the methods of nlysis for multiperiod sitution uild on those of erlier hptersF snternl rte of returnD S

present vlueD the omprison prinipleD portfolio designD nd lttie nd tree vlution ll hve nturl extensions to generl situtionsF fut onlusions suh s voltility is 4d4 or diversi(tion is 4good4 re no longer universl truthsF he story is muh more interestingF4 sn se of g we (x portfolio vetor b P d D iFeFD we re onerned with hypothetil investor who neither onsumes nor deposits new sh into his portfolioD ut reinvest his portfolio eh trding periodF xote tht in this se the investor hs to relne his portfolio fter eh trding dy to orrigte the dily prie shifts of the invested stoksF vet SH denote the investor9s initil pitlF hen t the eginning of the (rst trding period SH b@j A is invested into sset j D nd it results in return @j A SH b@j A xI D therefore t the end of the (rst trding period the investor9s welth eomes
SI

a SH

d X

where h ; i denotes inner produtF por the seond trding periodD SI is the new initil pitl
SP

aI

b@j A xI

@j A a S

H h b ; xI i ;

a S I h b ; x P i a SH h b ; x I i h b ; x P i :
Sn

fy indutionD for the trding period n the initil pitl is SnI D therefore

a SnI hb ; xni a SH hb ; xii :


i

n Y

aI

he symptoti verge growth rte of this portfolio seletion is

I I lim I ln Sn a nlim n ln SH C n 3I n3I n I a nlim n 3I


n X i

n X i

aI

ln hb ; xii

aI

ln hb ; xii ;

therefore without loss of generlity one n ssume in the sequel tht the initil pitl SH F

aI

2.1

Log-optimal portfolio for memoryless market process

sf the mrket proess fXi g is memorylessD iFeFD it is sequene of independent nd identilly distriuted @iFiFdFA rndom return vetors then we show tht T

the est onstntly relned portfolio @fgA is the logEoptiml portfolioX

P d his optimlity mens tht if Sn a


b

Xa rg mx Efln hb ; XIig:
Sn b denotes the pitl fter dy

n hieved y logEoptimum portfolio strtegy b D then for ny portfolio strtegy b with (nite E b ; XI P nd with pitl Sn Sn b nd

@ A

iA g for ny memoryless mrket proess fXn gI D I

f@ln h

a @A

I lim n ln Sn n3I

I lim n ln Sn n3I

lmost surely

nd mximl symptoti verge growth rte is

I lim n ln Sn a W Xa Efln hb ; XIig n3I


W b

lmost surelyF

he proof of the optimlity is simple onsequene of the strong lw of lrge numersF sntrodue the nottion

@ A a Efln hb ; XIig:

hen

I ln Sn a I n n I a n a I
n X i

n X i

n X i

aI aI

ln hb ; Xii
Efln hb ; Xi ig C
n X i

W b

I @ AC n

n X i

aI

@ln hb ; Xii Efln hb ; XiigA

aI

@ln hb ; Xii Efln hb ; XiigA :


lmost surelyD

he strong lw of lrge numers implies tht


n

aI

@ln hb ; Xii Efln hb ; XiigA 3 H

therefore

I lim n ln Sn a W @bA a Efln hb ; XIig 3I


n

lmost surelyF

imilrlyD

I lim n ln Sn a W @bA a mx W @bA 3I b


U

lmost surelyF

e hve to emphsize the si onditions of the modelX ssume tht

@iA the ssets re ritrrily divisileD nd they re ville for uying or for selling in unounded quntities t the urrent prie t ny given trding periodD @iiA there re no trnstion ostsD @iiiA the ehvior of the mrket is not 'eted y the tions of the investor using the strtegy under investigtionF evoiding @iiAD see etion SF por memoryless or wrkovin mrket proE essD optiml strtegies hve een introdued if the distriutions of the mrket proess re knownF here is no symptotilly optimlD empiril lgorithm tking into ount the trnstion ostF gondition @iiiA mens tht the mrket is ine0ientF he priniple of logEoptimlity hs the importnt onsequene tht
Sn b

@A

is not lose to

EfSn @bAg:

e prove it moreF he optimlity property proved ove mens thtD for ny  > D the event

 < I ln Sn@bA Efln hb ; XIig < 

hs proility lose to property implies tht




I if n is lrge enoughF

yn the one hndD the iFiFdF




I a  C Efln hb ; XIig < n ln Sn@bA <  C Efln hb ; XIig a en@CEflnhb ; X igA < Sn@bA < en@CEflnhb ; X igA ;
 n
1 1

 < I ln Sn@bA Efln hb ; XIig < 


n

therefore yn the other hndD

Sn b
(

@A

is lose to enEflnhb ; X1 ig :
)

EfSn @bAg a E

n Y i

aI

hb ; Xii a

n Y i

aI

hb ; EfXigi a en lnhb ; EfX gi:


1

fy tensen inequlityD

ln hb ; EfXIgi > Efln hb ; XIig;


V

therefore

Sn b

@A

is muh less thn

EfSn @bAg:

xot knowing this ftD one n pply nive pproh

rg mx EfSn@bAg:
b

feuse of

EfSn @bAg a hb ; EfXI gin ;

this nive pproh hs the equivlent form

rg mx EfSn@bAg a rg mx hb ; EfXIgi ;
b b

whih is lled the men pprohF st is esy to see tht b hb ; EfXI gi is portfolio vetor hving t the positionD where EfXI g hs the lrgest omponentF sn his seminl pper wrkowitz QP relized tht the men pproh is indequteD iFeFD it is dngerous portfolioF sn order to void this di0ulty he suggested diversi(tionD whih is lled menEvrine portfolio suh tht b hb ; EfXIgi ;

rg mx

~a

where  > is the risk version prmeterF por pproprite hoie of D the performne @verge growth rteA of b n e lose to the performne of the optiml b D howeverD the good hoie of  depends on the @unknownA distriution of the return vetor XF he lultion of b is nonliner progrmming @xvA prolemD where liner funtion is mximized under qudrti onstrintsF sn order to lulte the logEoptiml portfolio b D one hs to know the distriution of XI F sf this distriution is unknown then the empiril logE optiml portfolio n e de(ned y

b Var b ; X1

rg mx
@h

iA

b
with liner onstrints
d X j

a rg mx I
b

n X i

aI

ln hb ; Xii I a I; : : : ; d :

aI

b@j A

aI

nd

H
W

b@j A

he ehvior of the empiril portfolio b nd its modi(tions ws studied n y wri QVD QW nd y worvi RID RPF he lultion of b is xv prolemD tooF gover IH introdued n n lgorithm for lulting b F en lterntive possiility is the softwre n routine of pellui RUF he routine is sed on sequentil qudrti progrmming methodD whih omputes sequentilly lol solution of xv y solving qudrti progrmming prolem nd it estimtes the glol mximum ording to these lol mximumsF

donlp2

2.2

Examples for constantly rebalanced portfolio

Example 1.

gonsider the exmple of d nd X X @IA ; X @PA suh tht the (rst omponent X @IA of the return vetor X is n rti(il stokX

aP

a@

X @IA a

P I=P

with proility = D with proility = D


X @PA

IP IP

@IA

nd the seond omponent X @PA is the shX

a I:

yviouslyD the sh hs zero growth rteF sing the expettion of the (rst omponent

EfX @IA g a I=P @P C I=PA a S=R > I;


@IA EfSn g a E
(

nd the iFiFdF property of the mrket proessD we get tht


n Y i

therefore EfSn g grows exponentillyF roweverD it does not imply tht the @IA rndom vrile Sn grows exponentillyD tooF vet9s lulte the growth rte W @IA X
W @IA

@IA

aI

@IA X
i

a @S=RAn;

@PA

I n I @IA Xa nlim n ln Sn a nlim n ln Xi@IA a Efln X @IAg 3I iaI 3I a I=P lnP C I=P ln@I=PA a H;
X

whih mens tht the (rst omponent hs zero growth rteD tooF he following viewpoint my help explin this t (rst sight surprising propertyF pirstD we write the evolution of the welth of the stok s followsX IH

PB@m; 2 An D where B n; I is inomil distriution rndom let Sn P vrile with prmeters n; I @it is esy to hek if we hoose n P then we return k to the oneEstep performne of stokAF xow we write ording to the woivreEvple theorem @ speil se of the entrl limit theorem for inomil distriutionAX

@IA

aP

aI

P @q

where  x is umultive distriution funtion of the stndrd norml disE triutionF errnging the leftEhnd side we hve
0

@A

I PB @n; P A n Var@PB @n; I AA n P

xA

9 @xA;

@q

I PB @n; P A n I Var@PB @n; P AA n

xA

I a P PB @n; P A n xpn p a P PPB@n; An Px n p @IA a P Sn P x n


 
1 2

Px n 9 @xA : xow let x" hoose so tht @x" A a I " then p @IA P Sn P x n 9 I " nd for (xed " > H let nH e so tht n p @IA Px n < ESn a S R
P
Sn


tht is

@IA

"

for ll n > nH then we hve

Sn

@IA ! ES @IA 
n

Sn

@IA ! Pxpn  9 ":

st mens tht most of the vlues of Sn re fr smller thn its expeted vlue @see in pigure IAF xow let9s turn k to the originl prolem nd lulte the logEoptiml portfolio for this return vetorD where oth omponents hve zero growth rteF he portfolio vetor hs the form

@IA

a @b; I bA:
II

pigure IX he distriution of Sn in se of n

@IA

aS

hen

portfolio is

@ A a Efln hb ; Xig a I=P @ln@Pb C @I bAA C ln@b=P C @I bAAA a I=P ln@I C bA@I b=PA: yne n hek tht W @bA hs the mximum for b a I=PD so the logEoptiml
W b

b
W

a @I=P; I=PA;

nd the symptoti verge growth rte is

a Efln hb ; Xig a I=P ln@W=VA a H:HSW; aQ a@ A

whih is positive growth rteF gonsider the exmple of d nd X X @IA ; X @PA ; X @QA suh tht the (rst nd the seond omponents of the return vetor X re rti(il stoks of form @IAD while the third omponent is the shF yne n show tht the logEoptiml portfolio is

Example 2.

a @H:RT; H:RT; H:HVA;

nd the mximl symptoti verge growth rte is


W

a Efln hb ; Xig a H:IIP: Q a@ A

Example 3.

gonsider the exmple of d > nd X X @IA ; X @PA ; : : : ; X @dA suh tht the (rst d omponents of the return vetor X re rti(il stoks of form @IAD while the lst omponent is the shF yne n show tht the logEoptiml portfolio is

a @I=@d IA; : : : ; I=@d IA; HA;


IP

whih mens thtD for d > D ording to the logEoptiml portfolio the sh hs zero weightF vet N denote the numer of omponents of X equl to D then N is inomilly distriuted with prmeters d ; = D nd

I I PA Q ln hb ; Xi a ln PN C @dd II N A=P a ln P@d N IA C I P


  

therefore por d rte is

W a Efln hb ; Xig a E

a RD the formul implies tht the mximl symptoti verge growth


W

Q ln P@d N IA C I P




while for d 3 ID
W

a Efln hb ; Xig a H:ISP;

a Efln hb ; Xig 3 ln@S=RA a H:PPQ;


Sn

whih mens tht so with mny suh stoks

% enW a @S=RAn;
Sn

% EfSng

@fF @PAAF

Example 4.

gonsider the exmple of horse ring with d horses in reF essume tht horse j wins with proility pj F he pyo' is denoted y oj D whih mens tht investing I6 on horse j results in oj if it winsD otherwise H6F hen the return vetor is of form

a @H; : : : ; H; oj ; H; : : : ; HA

if horse j winsF por repeted resD it is onstntly relned portfolio prolemF vet9s lulte the expeted logEreturnX
W b

@ A a Efln hb ; Xig a

d X j

aI

pj

ln@b@jAoj A a

d X j

aI

pj

ln b@jA C ln b@jA:

d X j

aI

pj

ln oj ;

therefore

rg mx Efln hb ; Xig a rg mx
b b

d X j

aI

pj

IQ

sn order to solve the optimiztion prolem

rg mx
b

d X j

aI

pj

ln b@jA; ln bpjjA : @

we introdue the uullkEveiler divergene of the distriutions p nd bX uv p; b

Aa @

d X j

aI

pj

he si property of the uullkEveiler divergene is tht uv p; b

A ! H;
b@j A pj
!

nd is equl to zero if nd only if the two distriutions re equlF he proof of this property is simpleX uv p; b

Aa

d X j

aI

pj

ln

b@j A pj

d X j

aI

pj

I a

d X j

aI

b@j A

d X j

aI

pj

a H:

his inequlity implies tht

rg mx
b

d X j

aI
d

pj

ln b@jA a p:

urprisinglyD the logEoptiml portfolio is independent of the pyo'sD nd


X W a pj ln@pj oj A:

aI

he usul hoie of pyo's is


oj

a pI ;
j

nd then

a H:

st mens thtD for this hoie of pyo'sD ny gmling strtegy hs negtive growth rteF

Example 5.

equentil tFetersurg gmesF gonsider the simple tFetersurg gmeD where the plyer invests IR

I dollr

nd fir oin is tossed until til (rst ppersD ending the gmeF sf the (rst til ppers in step k then the the pyo' X is k nd the proility of this event is k X

ine EfX g ID this gme hs delite properties @fF eumnn RD fernoulli TD hurnd IRD righ PRD wrtin QRD wenger QSD ieger nd ng RQ nd muelson RRFA sn the litertureD usully the repeted tFetersurg gme @lled iterted tFetersurg gmeD tooA mens multiE period gme suh tht it is sequene of simple tFetersurg gmesD where in eh round the plyer invest dollrF vet Xn denote the pyo' for the nEth simple gmeF essume tht the sequene fXn gI is independent nd naI identilly distriutedF efter n rounds the plyer9s welth in the repeted gme is

PfX a Pk g a Pk :

Sn

~ a

n X i

aI

Xi :

gsrg nd imons IQ proved tht

in proilityD where

logP denotes the logrithm with se PF woreoverD ~ Sn lim inf n log n a I n3I P ~ Sn lim sup n log n a I n3I
P
Xn Sn

~ Sn lim n log n a I n3I


P

FsF nd

FsFD while introduing the nottion for the lrgest pyo'

a Imxn Xi i
~ a Sn Xn;

nd for the sum with the lrgest pyo' withheld

one hs tht

Sn lim n log n a I n3I

IS

FsF eording to the previous results Sn % n P nF xext we introdue multiEperiod gmeD lled sequentil tFetersurg gmeD hving exponenE til growthF he sequentil tFetersurg gme mens tht the plyer strts with initil pitl SH dollrD nd there is n independent sequene of simple tFetersurg gmesD nd for eh simple gme the plyer reinvest @cA his pitlF sf SnI is the pitl fter the n Eth simple gme then the

log

aI

@cA invested pitl is S


n

simple gme with ommission ftor round the pitl is


Sn

@I cAD while S @cA


n

H < c < IF st mens tht fter the nEth


n Y i

I c is the proportionl ost of the


n Y i

IA

@cA a S @cA

n nI @I cAXn a SH @I cA

aI

Xi

a @I cAn

aI

Xi :

feuse of its multiplitive de(nitionD Sn hs exponentil trendX


Sn
( @cA a enWnc) % enW (c) ;

@cA

with verge growth rte


Wn

@cA Xa

I ln SncA @

nd with symptoti verge growth rte


W @cA

I @ Xa nlim n ln SncA: 3I
n

vet9s lulte the the symptoti verge growth rteF feuse of

@cA a W
n

I ln SncA a I @

ln@I cA C

n X i

aI

ln Xi

the strong lw of lrge numers implies tht


W @cA

I a ln@I cA C nlim n 3I

n X i

aI

ln Xi a ln@I cA C Efln XIg

FsFD so W @cA n e lulted vi expeted logEutility @fF uenneth PWAF e ommission ftor c is lled fir if
W @cA

a H;

IT

so the growth rte of the sequentil gme is F vet9s lulte the fir cX

ln@I cA a Efln XIg a


iFeFD
c

aI

ln P Pk a P lnP;

a Q=R: I aI

xext we study the portfolio gmeD where frtion of the pitl is invested in the simple fir tFetersurg gme nd the rest is kept in shF his is the model of the onstntly relned portfolio @gAF pix portfolio vetor b b; b D with b F vet SH denote the plyer9s initil pitlF hen t the eginning of the portfolio gme SH b b is invested into the fir gmeD nd it results in return bXI = D while SH b b remins in shD therefore fter the (rst portfolio gme the plyer9s welth eomes

a@ I A

a @I

AaI

SI

a SH@bXI=R C @I bAA a b@XI=R IA C I:

por the seond portfolio gmeD SI is the new initil pitl


SP

a SI@b@XP=R IA C IA a @b@XI=R IA C IA@b@XP=R IA C IA:


Sn

fy indutionD for nEth portfolio gme the initil pitl is SnI D therefore

a SnI@b@Xn=R IA C IA a @b@Xi=R IA C IA:


i

n Y

aI

he symptoti verge growth rte of this portfolio gme is


W b

I @ A Xa nlim n ln Sn 3I n a lim I ln@b@Xi=R IA C IA


X

3 Efln@b@XI=R IA C IAg
FsF he funtion is onveD therefore W b is onveD tooD so W @keep everything in shA nd W @the simple gme is firA imply tht for ll < b < D W b > F vet9s lulte

3I n iaI

ln

@A H

@IA a H

@A

@HA a H

mx W @bA: b
IU

W b

H HFI HFP HFQ HFR HFS HFT HFU HFV HFW I

H HFHTI HFHVR HFHWS HFHWU HFHWQ HFHVQ HFHTV HFHRW HFHPS H

@A

le IX he symptoti verge growth rte of the portfolio gmeF

e hve tht
W b

@A a

a ln@I b=PA PI C a HR @ A a H HWU

aI

ln@b@Pk =R IA C IA Pk
X

aQ

ln@b@PkP IA C IA Pk : RH7 QH7

le I shows some (gures on the verge growth rte of the portfolio gmeF sf b : then W b : D so if for eh gme one reinvest of his pitl suh tht the rel investment is D while the ost is D then the growth rte is pproximtely D iFeFD the portfolio gme with two omponents of growth rte @fir tFetersurg gme nd shA n result in growth rte of F

IH7

IH7

IH7

2.3

Semi-log-optimal portfolio

jd RW suggested n pproximtion of b nd b using n


h z

whih is the seond order ylor expnsion of the funtion henD the semiElogEoptiml portfolio seletion is

@ A Xa z I I @z IAP; P

ln z t z a IF

" a rg mx Efh@hb ; xIiAg;


b

IV

nd the empiril semiElogEoptiml portfolio is

I " bn a rg mx
b

n X i

sn order to ompute b D one hs to mke n optimiztion over bF sn eh n optimiztion step the omputtionl omplexity is proportionl to nF por bn D this omplexity n e reduedF e hve tht

aI

h b ; xi :

@h

iA

"

n X i

aI

h b ; xi

@h

I iA a n

n X i

sf 1 denotes the ll

I vetorD then I n h@hb ; xiiA a hb ; mi hb ; Cbi ;


X

aI

I n @hb ; xii IA I n @hb ; xii IAP: P


X

aI

aI

where

m
nd

I a n @xi 1A
n X i

aI

I I n @xi 1A@xi 1AT : Ca P n iaI


X

sf we lulte the vetor m nd the mtrix C eforehnd then in eh optimiztion step the omplexity does not depend on nD so the running time for lulting bn is muh smller thn for b F he other dvntge n of the semiElogEoptiml portfolio is tht it n e lulted vi qudrti progrmmingD whih is doleD eFgFD using the routine of hi qspero ITF his progrm uses qoldfrEsdnni dul method for solving qudrti progrmming prolems IUF st esy to see tht mtrix C is posiE tive semiEde(nitD howeverD the ove mentioned dul method is only fesile if C is positive de(niteF his di'erene hs not used ny prolems in the experimentsD ut in se of usl empiril strtegies sometimes C is lE ulted from few dtD nd so C is not fullErnk mtrixD whih implies tht C is only positive semiEde(niteF pinlly we revel surprising property of the semiElog optiml portfolioF

"

QuadProg++

IW

vet us use the de(nition of the funtion hD then we hve tht

Efh@hb ; xI iAg

a a a a

I Ef@hb ; xI i IAg Ef@hb ; xI i IAP g P I Efhb ; xIiP P hb ; xIi Ig Efhb ; xI ig I P Q C PEfhb ; xIig I Efhb ; xIiPg P P I I Ef@hb ; xIi PAPg; P P
b

therefore

" a rg mx Efh@hb ; xIiAg a rg min Ef@hb ; xIi PAPg:


b

husD b n e onsidered s the prinipl omponent for portfolio seletion suh tht for b bD hb ; xI i pproximtes est the vlue in men squre senseF

"

a"

Time varying portfolio selection

por generl dynmi portfolio seletionD the portfolio vetor my depend @IA @dA denotes the return vetor on the pst dtF es eforeD xi xi ; : : : xi on trding period iF vet b bI e the portfolio vetor for the (rst trding periodF por initil pitl SH D we get tht

a@

SI

a S H h bI ; x I i :

por the seond trding periodD SI is new initil pitlD the portfolio vetor is bP b xI D nd

a @ A A

SP

a SH hbI ; xIi hb@xIA ; xPi :


n YD

por the nth trding periodD portfolio vetor is bn b xnI nd I

a b@xI; : : : ; xnIA a

Sn

a SH

with the verge growth rte


Wn B

aI

b xiI ; xi I

a SHenW @BA
n
E

I @ Aa n

n X i

aI

ln b@xiIIA ; xi
D

PH

3.1

Log-optimal portfolio for stationary market process

he fundmentl limitsD determined in wri QTD in elgoet nd gover QD nd in elgoet ID PD revel tht the soElled log-optimum portfolio B fb g is the est possile hoieF wore preiselyD on trding period n let b e suh tht

@A @A
E
n

ln

b XnI ; Xn I

XnI I

a mx E ln b@XnIA ; Xn I b@A
n D

XnI : I
o

Sn B denotes the pitl hieved y logEoptimum portfolio sf Sn strtegy B D fter n trding periodsD then for ny other investment strtegy B with pitl Sn Sn B nd with

a @ A

a @ A sup E @ln n
n

bn XnI ; Xn I

AP

<

I;

nd for ny sttionry nd ergodi proess fXn gI D I

I lim sup n ln Sn H S n3I


n n

lmost surely

@QA

nd where

I lim n ln Sn a W 3I
(

lmost surelyD
)

W Xa E

mx E ln b@A a mx

o E b@XI A ; XH XI I I

is the mximl possile growth rte of ny investment strtegyF @xote tht for memoryless mrkets W b E f hb ; XH ig whih shows tht in this se the logEoptiml portfolio is onstntly relned portfolioFA

ln

por the proof of this optimlity we use the onept of mrtingle di'erE enesX

fXng such that

Denition 1 There are two sequences of random variables


Zn is a function of XI ; : : : ; Xn ,

fZng

and

EfZn j XI ; : : : ; XnI g a H almost surely.

Then fZn g is called martingale dierence sequence with respect to fXn g.


PI

por mrtingle di'erene sequenesD there is strong lw of lrge numE ersX sf fZn g is mrtingle di'erene sequene with respet to fXn g nd
X

I EfZ P g n

then

aI
i

nP

<

I lim n n3I

n X

@fF ghow WD see lso tout RVD heorem QFQFIAF sn order to e selfEontinedD for mrtingle di'erenesD we prove wek lw of lrge numersF e show tht if fZn g is mrtingle di'erene sequene with respet to fXn g then fZn g re unorreltedF ut i < j D then

aI

Zi

a H FsF

EfZi Zj g

a EfEfZiZj j XI; : : : ; XjIgg a EfZiEfZj j XI; : : : ; XjIgg a EfZi Hg a H:


!

st implies tht

aI iaI j aI P g is ounded sequeneF ifD for exmpleD EfZi


i
;

E:

8 <

n X

P9 =

Zi

I a nP

n n XX

EfZi Zj g a P n

n X i

aI

EfZiP g 3 H

yne n onstrut mrtingle di'erene sequene s followsX let fYn g e n ritrry sequene suh tht Yn is funtion of XI ; : : : ; Xn F ut hen fZn g is mrtingle di'erene sequeneX Zn is funtion of XI ; : : : ; Xn D
Zn

a Yn EfYn j XI; : : : ; XnIg:

EfZn j XI ; : : : ; XnI g a EfYn EfYn j XI ; : : : ; XnI g j XI ; : : : ; XnI g a

H lmost surelyF
n X i

xow we n prove of optimlity of the logEoptiml portfolioX introdue the deomposition

I ln Sn a I n n I a n I C n

n X i

aI aI aI

ln b@XiIIA ; Xi
D

Efln
D

b XiI ; Xi I

j XiIIg
D E 

n X i

ln b@XiIIA ; Xi Efln b@XiIIA ; Xi j XiIIg


E

PP

he lst verge is n verge of mrtingle di'erenesD so it tends to zero FsF imilrlyD

I ln S a I n n n I C n
D

n X i

n X i

aI aI

Efln

b XiI ; Xi I

j XiIIg
D

ln

b XiI ; Xi I

Efln
D

b X i I ; X i I

j XiIIg

feuse of the de(nition of the logEoptiml portfolio we hve tht

Efln

b X i I ; X i I

j XiIIg Efln

b X i I ; X i I

j XiIIg;

nd the proof is (nishedF


3.2 Empirical portfolio selection

he optimlity reltions proved ove give rise to the following de(nitionX

Denition 2 An empirical (data driven) portfolio strategy B is called universally consistent with respect to a class g of stationary and ergodic processes fXn gI , if for each process in the class, I
n

I lim n ln Sn@BA a W 3I

almost surely.

st is not t ll ovious tht suh universlly onsistent portfolio strtegy existsF he surprising ft tht there exists strtegyD universl with respet to the lss of ll sttionry nd ergodi proesses ws proved y elgoet IF wost of the ppers deling with portfolio seletions ssume tht the disE triutions of the mrket proess re knownF sf the distriutions re unknown then one n pply two stge splitting shemeF IX sn the (rst time period the investor ollets dtD nd estimtes the orresponding distriutionsF sn this period there is no ny investmentF PX sn the seond time period the investor derives strtegies from the distriution estimtes nd performs the investmentsF sn the sequel we show tht there is no need to mke ny splittingD one n onstrut sequentil lgorithms suh tht the investor n mke trding during the whole time periodD iFeFD the estimtion nd the portfolio seletion is mde on the whole time periodF PQ

vet9s repitulte the de(nition of logEoptiml portfolioX

Efln

n b X I I ; X n

por (xed integer k >


D

H lrge enoughD we expet tht n Efln b@XI I A ; Xn j XnI g % Efln b@XnI A ; Xn j XnI g I nk nk
E D E

j XnIg a mx Efln b@XnIA ; Xn j XnIg : I I I b@A


D E

nd
n b XI I

A % bk @XnI A a rg mx Efln b@XnI A ; Xn j XnI g: nk nk nk


D E

@A

feuse of sttionrity

bk x k I

@ A a rg mx Efln b@XnI A ; Xn j XnI a xk g I nk nk


D E

a rg mx Efln b@xk A ; XkCI j Xk a xk g I I I b@A a rg mx Efln hb ; XkCIi j Xk a xk g; I I


b

@A

whih is the mximiztion of the regression funtion


mb xk I

@ A a Efln hb ; XkCIi j Xk a xk g: I I

husD possile wy for symptotilly optiml empiril portfolio seletion is thtD sed on the pst dtD sequentilly estimte the regression funtion mb xk D nd hoose the portfolio vetorD whih mximizes the regression I funtion estimteF

@ A

3.3

Regression function estimation

frie)y summrize the sis of nonprmetri regression funtion estimE tionF gonerning the detils we refer to the ook of qyr(D uohlerD urzyzk nd lk IVF vet Y e rel vlued rndom vrileD nd let X denote rndom vetorF he regression funtion is the onditionl expettion of Y given X X sf the distriution of X; Y is unknown then one hs to estimte the regresE sion funtion from dtF he dt is sequene of iFiFdF opies of X; Y X
Dn

m x

@ A a EfY j X a xg:

a f@XI; YIA; : : : ; @Xn; YnAg:


PR

he regression funtion estimte is of form


mn x

@ A a mn@x; DnA:
Wni x XI ; : : : ; Xn Yi ;

en importnt lss of estimtes is the lol verging estimtes


mn x

@ Aa

n X i

aI

@Y

where usully the weights Wni x XI ; : : : ; Xn re nonEnegtive nd sum up to F woreoverD Wni x XI ; : : : ; Xn is reltively lrge if x is lose to Xi D otherwise it is zeroF en exmple of suh n estimte is the partitioning estimateF rere one hooses (nite or ountly in(nite prtition n fAn;I ; An;P ; : : : g of Rd onsisting of ells An;j  Rd nd de(nesD for x P An;j D the estimte y verging Yi 9s with the orresponding Xi 9s in An;j D iFeFD

@Y

@Y

mn x

@ Aa

Pn

Pn

aI IfXi PAn;j g Yi iaI IfXi PAn;j g


IfXi PAn;j g

for x P An;j ;

@RA

where IA denotes the inditor funtion of set AD so


Wn;i x

@ Aa

Pn

rere nd in the following we use the onvention H F sn order to hve H onsistenyD on the one hnd we need tht the ells An;j should e 4smll4D nd on the other hnd the numer of nonEzero terms in the denomintor of @RA should e 4lrge4F hese requirements n e stis(ed if the sequenes of prtition n is symptotilly (neD iFeFD if

aI IfXl PAn;j g

for x P An;j :

aH

dim@AA a sup kx yk
x;y A

denotes the dimeter of set suh tht eh sphere S entered t the origin
n
n;j

jj jj is the iuledin normD then for

lim jXAmx TaY dim@An;j A a H 3I S

nd

lim jfj X An;jn S Ta Ygj a H: n3I


PS

por the prtition n D the most importnt exmple is when the ells An;j re ues of volume hd F por ui prtitionD the onsisteny onditions ove n men tht hn nd nhd I: @SA n
n

lim a H 3I H

lim 3I

he seond exmple of lol verging estimte is the Nadaraya Watson kernel estimateF vet K Rd 3 RC e funtion lled the kernel funtionD nd let h > e ndwidthF he kernel estimte is de(ned y

mn x

@ Aa

Pn

Y aI K  h i  i ; Pn K xXi iaI h
i

x X

@TA

so
Wn;i x

@ Aa

K
Pn

aI

x Xi h  : x Xj K h

rere the estimte is weighted verge of the Yi D where the weight of Yi @iFeFD the in)uene of Yi on the vlue of the estimte t xA depends on the distne etween Xi nd xF por the ndwidth h hn D the onsisteny onditions re @SAF sf one uses the soElled nive kernel @or window kernelA K x Ifkxk Ig D where Ifg denotes the inditor funtion of the events in the rketsD tht isD it equls if the event is true nd otherwiseF hen

@ Aa

mn x

@ Aa

Pn

Pn

iFeFD one estimtes m x y verging Yi 9s suh tht the distne etween Xi nd x is not greter thn hF yur (nl exmple of lol verging estimtes is the k-nearest neighbor @kExxA estimateF rere one determines the k nerest Xi 9s to x in terms of distne kx Xi k nd estimtes m x y the verge of the orresponding Yi 9sF wore preiselyD for x P Rd D let

@A

aI IfkxXi k hg Yi ; iaI IfkxXi k hg

@A

@X@IA@xA; Y@IA@xAA; : : : ; @X@nA@xA; Y@nA@xAA


e permuttion of suh tht

@XI; YIA; : : : ; @Xn; YnA

kx X@IA@xAk kx X@nA@xAk:
PT

he kExx estimte is de(ned y


mn x

I @ Aa k I a

k X i

rere the weight Wni x equls =k if Xi is mong the k nerest neighors of xD nd equls otherwiseF sf k kn 3 I suh tht kn =n 3 then the kEnerestEneighor regression estimte is onsistentF

@A

aI

Y@iA x :

@A

@UA

e use the following orrespondene etween the generl regression esE timtion nd portfolio seletionX

$ Xk ; I Y $ ln hb ; XkCI i ; m@xA a EfY j X a xg $ mb @xk A a Efln hb ; XkCI i j Xk a xk g: I I I


X
3.4 Histogram based strategy

xext we desrie histogram based strategy due to qyr( nd hfer PH nd denote it y BH F e (rst de(ne n in(nite rry of elementry strteE gies @the soElled expertsA B@k;`A fb@k;`A gD indexed y the positive integers k; ` ; ; : : :F ih expert B@k;`A is determined y period length k nd y prtition ` fA`;j gD j ; ; : : : ; m` of Rd into m` disjoint C setsF o determine its portfolio on the nth trding periodD expert B@k;`A looks t the mrket vetors xnk ; : : : ; xnI of the lst k periodsD disretizes this kdEdimensionl vetor y mens of the prtition ` D nd determines the portfolio vetor whih is optiml for those pst trding periods whose preeding k trding periods hve identil disretized mrket vetors to the present oneF pormllyD let G` e the disretiztion funtion orresponding to the prtition ` D tht isD

aI P

@A

aIP

G` x

@ A a j; if x P A`;j :

ith some use of nottionD for ny n nd xn P Rdn D we write G` xn for I I the sequene G` xI ; : : : ; G` xn F hen de(ne the expert B@k;`A fb@k;`A g y writingD for eh n > k D

@ A CI b@k;`A @xnI A a rg mx I
b

@ A

@ A @A

where Jk;l;n a

k < i < n G` xiI i k

Pd iPJk;l;n

h b ; xi i

;
o

@VA
;

X @

A a G`@xnI A nk

PU

if Jk;l;n T YD nd uniform bH =d; : : : ; =d otherwiseF ht isD bn nI ording to the prtition ` D nd rowses disretizes the sequene xI through ll pst ppernes of the lst seen disretized string G` xnI of nk length kF hen it designs (xed portfolio vetor optimizing the return for the trding periods following eh ourrene of this stringF he prolem left is how to hoose k; `F here re two extreme sesX

a @I

I A

@k;`A

smll k or smll ` implies tht the orresponding regression estimte hs lrge isD lrge k nd lrge ` implies tht usully there re few mthingD whih results in lrge vrineF he goodD dt dependent hoie of k nd ` is dole orrowing urrent tehniques from mhine lerningF sn mhine lerning setup k nd ` re onsidered s prmeters of the estimtesD lled expertsF he si ide of mhine lerning is the omintion of the expertsF he omintion is n ggregted estimteD where n expert hs lrge weight if its pst performne is good @fF gesEfinhi nd vugosi VAF he most suessful omintion is the exponentil weightingF gomine @k;`A the elementry portfolio strtegies B@k;`A fbn g s followsX let fqk;` g e proility distriution on the set of ll pirs k; ` suh tht for ll k; `D qk;` > F por  > D introdue the exponentil weights

@ A
A:

wn;k;`

a qk;`e ln S @B
n 1 n 1
(k;`)

(k;`)

por 

a ID it mens tht wn;k;` a qk;` eln S @B


vn;k;`

A a qk;` SnI @B@k;`A A


wn;i;j :

nd

wn;k;`
i;j

he omined portfolio b is de(ned y

bn xnI I

Aa

XX

I I

aI `aI

vn;k;` bn

@k;`A @xnI A: I

PV

his omintion hs simple interprettionX


Sn B

@ A a
H

n YD i

aI aI

b i x i I ; x i I

a a a a a

n Y i

k;` wi;k;` bi
P

@k;`A @xiI A ; x E i I
wi;k;`

@k;`A @xiI A ; x E i I P @k;`A A k;` qk;` SiI @B iaI P n @k;`A A Y k;` qk;` Si @B P @k;`A A k;` qk;` SiI @B iaI X qk;` Sn @B@k;`A A:
n Y
P

@k;`A k;` qk;` SiI B

k;`

bi

k;`

he strtegy BH then rises from weighting the elementry portfolio strteE @k;`A gies B@k;`A fbn g suh tht the investor9s pitl eomes
Sn BH

@ Aa

qk;` Sn B@k;`A :

k;`

@WA

st is shown in PH tht the strtegy BH is universlly onsistent with respet to the lss of ll ergodi proesses suh tht Efj X @j A jg < ID for ll j ; ; : : : ; d under the following two onditions on the prtitions used in the disretiztionX

aI P

log

aI P @A if dim@AA a supx;yPA kx yk denotes the dimeter of setD then for


ny sphere S

@A the sequene of prtitions is nestedD tht isD ny ell of `CI is suset of ell of ` D ` ; ; : : :Y

& Rd entered t the originD


`
`;j

lim jXAmx TaY dim@A`;j A a H : 3I S a @A

3.5

Kernel based strategy

qyr(D vugosiD din IW introdued kernel-based portfolio selection strteE giesF he(ne n in(nite rry of experts B@k;`A fb@k;`A gD where k; ` re positive integersF por (xed positive integers k; `D hoose the rdius rk;` > suh tht for ny (xed kD

lim rk;` a H: 3I
PW

henD for n > k

C ID de(ne the expert b@k;`A y n b@k;`A @xI I A a rg mx


X

P d

if the sum is nonEvoidD nd bH =d; : : : ; =d otherwiseF hese experts re mixed s in @WAF qyr(D vugosiD din IW proved tht the portfolio sheme BK B is universlly onsistent with respet to the lss of ll ergodi proesses suh tht Efj X @j A jg < ID for j ; ; : : : dF keth of the proofX feuse of the fundmentl limit @QAD we hve to prove tht Sn B ! W FsF Wn B

a @I

k<i<n xi 1 i k

n Xk xn1 k k

rk;`

I A

ln hb ; xii

ln

aI P

lim inf n3I

e hve tht

I @ A a lim inf n ln @ A n3I


0 @

Wn B

I @ A a n ln Sn@BA a I ln qk;`Sn@B@k;`AA
X

1 A !

I ! n ln sup qk;`Sn@B@k;`AA k;` a I sup ln qk;` C ln Sn@B@k;`AA




k;`

k;`

a sup
k;`

Wn B@k;`A

q A C ln nk;`

hus

lim inf Wn@BA ! lim inf sup n3I n3I


k;`

ln qk;` Wn @B@k;`A A C
Wn B@k;`A

a sup lim inf Wn@B@k;`AA k;` n3I a sup k;`:


k;`

! sup lim inf n3I


k;`

q A C ln nk;`

feuse of

lim`3I rk;` a HD we n show tht sup k;` a klim llim k;` a W : 3I 3I


k;`

QH

3.6

Nearest neighbor based strategy

he(ne n in(nite rry of experts B@k;`A fb@k;`A gD where < k; ` re integersF tust like eforeD k is the window length of the ner pstD nd for eh ` hoose p` P ; suh tht

@A

@H IA

lim p` a H: 3I
`

@IHA

ut

a p`n:

et given time instnt nD the expert serhes for the ` nerest neighor @xxA mthes in the pstF por (xed positive integers k; ` @n > k ` AD introdue the set of the ` nerest neighor mthesX

C C I

Jn

@k;`A a fiY k C I

n in xk ; : : : ; xnP I g: I k

n suh tht xiI is mong the ` xxs of xnI i k nk

he(ne the expert y


n b@k;`A xI I

A a rg mx
b

Pd iPJ(k;`) n

hb ; xii :

ht isD bn is (xed portfolio vetor ording to the returns following these nerest neighorsF hese experts re mixed in the sme wy s in @WAF e sy tht tie ours with proility zero if for ny vetor s sk I the rndom vrile kXk sk I

@k;`A

hs ontinuous distriution funtionF qyr(D dinD nd lk PI proved the following theoremX ssume @IHA nd tht tie ours with proility zeroD the the portfolio sheme BN N is universlly onsistent with respet to the lss of ll sttionry nd ergodi proesses suh tht Efj X @j A jg < ID for j ; ; : : : dF

log

aI P

3.7

Numerical results on empirical portfolio selection

his setion gives some empiril results on the fg seletionF et the we pge wwwFszitFmeFhuGotiGportfolio there re two enhmrk dt set from X

NYSE

QI

he (rst dt set onsists of dily dt of QT stoks with length PP yers @STSI trding dys ending in IWVSAF wore preiselyD the dt set ontins the dily prie reltivesD tht ws lulted from the nominl vlues of the closing prices orreted y the dividends nd the splits for ll trding dyF his dt set hs een used for testing portfolio seletion in gover IID in inger RTD in qyr(D vugosiD din IWD in qyr(D dinD lk PI nd in qyr(D rnD jd PPF he seond dt set ontins PQ stoks nd hs length RR yers @IIIUV trding dys ending in PHHTA nd it ws generted sme wy s the previous dt set @it ws ugmented y the lst PP yersAF yur experiment is on the second data set suh tht we left out four smll ssets @riD uyheuD gywwiD usxeA hving smll pitliztion @less thn IH dollrsAF o mke the nlysis fesileD some simplifying ssumptions re used tht need to e tken into ountF essume

IH

the ssets re ritrrily divisileD the ssets re ville in unounded quntities t the urrent prie t ny given trding periodD there re no trnstion osts @in etion S we o'er solutions to overE ome this prolemAD the ehvior of the mrket is not 'eted y the tions of the investor using the strtegy under investigtionF por the IW lrge ssetsD the verge nnul yield @eeA of the (xed uniform portfolio is X BBBqyuriBBBD while the ee of the onstntly relned uniform portfolio is X BBBqyuriBBBF le P summrizes the numeril results for IW lrge ssetsF he est sset ws wys with ee F he (rst olumn of le P lists the stok9s nmeD the seond olumn shows the eeF he third nd the fourth olumns present the weights of the stoks @the omponents of the portfolio vetorA using the logEoptiml nd semiElogEoptiml lgorithmsF urprisinglyD the two portfolio vetors re lmost the smeD ording to nextEtoEtheElst row the growth rtes re the smeX X BBBqyuriBBBF he lst row shows the running times of the lgorithmsF here were no di'erene etween the otined verge nnul

IW7

PI7

PH7

PQ7

QP

yield of the methodsD howeverD the running time is signi(ntly shorter for semiElogEoptiml lgorithmF

Stock's name AHP ALCOA AMERB COKE DOW DUPONT FORD GE GM HP IBM INGER JNJ KIMBC MERCK MMM MORRIS PANDG SCHLUM AAY running time (sec)

AAY 13% 9% 14% 14% 12% 9% 9% 13% 7% 15% 10% 11% 16% 13% 15% 11% 20% 13% 15%

BCRP log-Grad weights slog-Grad weights 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0.0304 0.0313 0 0 0 0 0 0 0 0 0 0 0 0 0.4573 0.4587 0 0 0 0 24% 24% 935 3

le PX gomprison of the two lgorithms for gsF por the lultion of the optiml portfolio we hve developed reE ursive F sntrodue the projetion P of vetor b b@IA ; : : : b@dA to d X

a@

gradient algorithm A

P b

@ Aa

Pd

aI b@j A

ut

Wn b

I @ Aa n

n X i

aI

log hb ; xii ;

QQ

nd let ej e the j Eth unit vetorD iFeFD its j Eth omponent is D the other omponents re F ghoose the initil vlues

bH
nd

a @I=d; : : : ; I=dA
VH

nd step size  > @sn our experiment we hd  por k ; ; :::D mke the following itertionX glulte

Step 1.

aI P

a Wn@bHA

a H:I=dFA

Wn P bkI

@ @

C  ej AA

a I; : : : ; d:

Step 2. sf

VkI

! mx Wn@P @bkI C  ej AA j

then stopD nd the result of the lgorithm is bkI F ytherwiseD put Vk Wn P bkI  ej

a mx @ @ j
bk

AA

nd where qo to

a P @bkI C  ej A;
j

a rg mx Wn@P @bkI C  ej AA:

Step 1F

yne n omine the kernel sed portfolio seletion nd the priniE ple of semiElogEoptiml lgorithm in etion PFQD lled kernel sed semiE logEoptiml portfolio @fF qyr(D rnD jd PPAF sn this setion we present some numeril results otined y pplying the kernel sed semiE logEoptiml lgorithm to the IW lrge ssets of the seond dt setF he proposed empiril portfolio seletion lgorithms use n in(nite rry of expertsF sn prtie we tke (nite rry of size K LF sn our experiment we seleted K nd L F ghoose the uniform distriution fqk;`g = KL over the experts in useD nd the rdius

NYSE

aI @ A

aS

a IH

P rk;l

a H:HHHP d k C H:HHHHP d k `;
QR

k `

I QI7 QR7 QS7 QS7 QR7 QS7 QQ7 QR7 QU7 QR7

P QH7 QI7 PW7 QH7 PW7 PW7 PW7 QQ7 QQ7 PW7

Q PR7 PU7 PT7 QH7 QQ7 PV7 QP7 QH7 PV7 PT7

R PI7 PS7 PR7 QP7 PR7 PR7 PQ7 PI7 IW7 PH7

S PT7 PP7 PQ7 PU7 PR7 PU7 PQ7 PR7 PI7 PR7

I P Q R S T U V W IH

le QX he verge nnul yields of the individul experts for the kernel strtegyF

@k

le Q summrizes the verge nnul yield hieved y eh expert t the lst period when investing one unit for the kernelEsed semiElogEoptiml portfolioF ixperts re indexed y k : : : in olumns nd ` ::: in rowsF he verge nnul yield of kernel sed semiElogEoptiml portfolio is F eording to le PD wys hd the est verge nnul yieldD D while the fg hd verge nnul yield BBBqyuriBBBD so with kernel sed semiElogEoptiml portfolio we hve spetulr improvementF enother interesting feture of le Q is tht for ny (xed `D the est k is equl to D so s fr s empiril portfolio is onerned the wrkovin modelling is ppropriteF

a I; : : : ; K nd ` a I; : : : ; LAF

aI S

a I IH

QI7 PH7

PQ7

e performed some experiments using nerest neighor strtegyF eginD we tke (nite rry of size K L suh tht K nd L F ghoose the uniform distriution fqk;` g = KL over the experts in useF le R summrizes the verge nnul yield hieved y eh expert t the lst period when investing one unit for the nerest neighor portfolio strtegyF ixperts re indexed y k : : : in olumns nd ` ; ;:::; in rowsD where ` is the numer of nerest neighorsF he verge nnul yield of nerest neighor portfolio is BBBendrisBBBF gompring les Q nd RD one n onlude tht the nerest neighor strtegy is more roustF

aI@ A

aS

a IH

aI S QS7

a SH IHH

SHH

QS

k `

I QI7 QQ7 QV7 QV7 QU7 RI7 QW7 QW7 QW7 RP7

P QQ7 QP7 QQ7 PV7 QI7 QS7 QT7 QS7 QR7 QT7

Q PV7 PS7 PT7 QP7 QU7 QS7 QI7 QQ7 QR7 QQ7

R PR7 PW7 QP7 QP7 PV7 QH7 QR7 QP7 QS7 QV7

S QS7 PV7 PU7 PR7 PT7 PW7 QP7 QS7 QU7 QS7

SH IHH ISH PHH PSH QHH QSH RHH RSH SHH

le RX he verge nnul yields of the individul experts for the nerest neighor strtegyF

Portfolio selection with consumption

por rel numer xD let xC e the positive prt of xF essume tht t the end of trding period n there is onsumption cn ! F por the trding period n the initil pitl is SnI D therefore

Sn

a @SnI hbn ; xni cnAC :


n X k

sf Sj >

H for ll j a I; : : : ; n then we show y indution tht


Sn

a SH hbi ; xii
i

n Y

aI

where the empty produt is D y de(nitionF por n @IIA for n X

aI

ck

n Y i k

a CI

hbi ; xii ;

@IIA

a ID @IIA holdsF essume


hbi ; xii :

SnI

a SH

n Y i

aI

hbi ; xii

n X k

aI

ck

n Y i k

a CI

QT

hen
Sn

a a a

SnI bn ; xn

@S

n Y i

i cn
k n X k

SH

n Y i

aI

hbi ; xii

n X

aI
ck

ck

n Y i k

aI

h bi ; x i i

n Y i k

a CI

hbi ; xii hbn ; xni cn


A

aI

a CI

hbi ; xii :

yne hs to emphsize tht @IIA holds for ll n i' Sn > for ll nD otherwise there is ruinF sn the sequelD we study the verge growth rte under no ruin nd the proility of ruinF fy de(nitionD

Pf ruin g

a P a P

8 <[ <

aI 8 aI :
(

fSn a Hg
SH
n Y i

aI

h bi ; x i i

n X k

aI

ck

n Y i k

a CI

hbi ; xii H

99 == ;;

therefore

Pf ruin g

a P
P P

n Y

aI (iaI
n Y
X

hbi ; xii SH hbi ; xii SH


ck Qk
i

n X k

aI

c k Qk
i

aI hbi ; xi i ! aI hbi ; xi i

H H

))

aI iaI
I
k

SH

aI

aI hbi ; xi i
n X

aI )

ck Qk
i

))

@IPA

nd

Pf ruin g

a P

n Y

! mx P n

aI( iaI
n Y i

hbi ; xii SH

a P

aI
k

hbi ; xii SH
ck Qk
i

k n X

aI

ck Qk
i

aI hbi ; xi i!

H H

))

SH

aI

aI hbi ; xi i
QU

aI )

ck Qk
i

aI hbi ; xi i

@IQA

@IPA nd @IQA imply tht

Pf ruin g a P

SH

aI

ck Qk
i

aI hbi ; xi i

nder no ruinD on the one hnd we get the upper ound on the verge growth rte
Wn

I a n ln Sn n I a n ln SH hbi ; xii
0 @ Y

n X k

I a n
Wn

I ln SH hbi ; xii n
n Y n X i i

aI

aI

ck

n Y i k

a CI

hbi ; xii

aI

I ln hbi ; xii C n ln SH:


1

aI

yn the other hnd we hve the lower ound

I a n ln Sn n I a n ln SH hbi ; xii
0 @ Y

n X k

I a n ln hbi ; xii
n Y

aI

I ! n ln I a n
i

n Y

aI aI

SH

n X k

aI

ck

n Y i k

a CI
i

hbi ; xii

i n X

hbi ; xii SH
n

aI aI

ck Qk ck Qk
i

aI hbi ; xi i ! aI hbi ; xi i
ck Qk
i

I I

aI

ln hbi ; xii C I ln

SH

I X
k

aI

aI hbi ; xi i

therefore under no ruin the symptoti verge growth rte with onsumpE tion is the sme s without onsumptionX

I I Wn a ln Sn %
n

n X i

aI

ln hbi ; xii : a c > HF hen there

gonsider the se of onstnt onsumptionD iFeFD cn is no ruin if


SH > c
X

aI

Qk

aI hbi ; xi i

QV

feuse of the de(nition of the verge growth rte we hve tht


Wk

I a k ln hbi ; xii ;
k Y i

aI

whih implies tht

aI

Qk

aI

a hb ; x i
i i

aI

ekWk :

essume tht our portfolio seletion is symptotilly optimlD whih mens tht
n

hen

lim Wn a W : 3I
%
X

his pproximtion implies tht the ruin proility n e smll only if eW SH > c eW :

aI

Qk

aI hbi ; xi i

aI

ekW

a I eW :

eW

e speil se of this model is when there is only one riskEfree ssetX


Sn

with some r > F yviouslyD there is no ruin if SH r > cF st is esy to verify tht this ssumption n e derived from the generl ondition if W
e

a @SnI@I C rA cAC a I C r:

he ruin proility n e deresed if the onsumptions hppen in loks of size N trding periodsF vet Sn denote the welth t the end of nEth lokF hen
0

Sn

@S

nN Y j

a@nIAN CI

hbj ; xj i N c

imilrly to the previous lultionsD we n hek tht under no ruin the verge growth rtes with nd without onsumption re the smeF woreover

Pf ruin g a P

SH

cN

aI

QkN

aI hbi ; xi i

QW

his ruin proility is monotonilly deresing funtion of N D nd for lrge N the ext ondition of no ruin is the sme s the pproximtion in the previous setionF his model n e pplied for the nlysis of portfolio seletion strtegies with (xed trnstion ost suh tht cn is the trnstion ost to e pid when hnge the portfolio bn to bnCI F sn this se the trnstion ost cn depends on the numer of shres involved in the trnstionF vet9s lulte cn F et the end of the nEth trding period nd efore @j A @j A pying for trnstion ost the welth t sset j is SnI bn xn D whih mens tht the numer of shres j is

@j A @j A @j A a SnI bn xn : mn @j A S
n

sn the model of (xed trnstion ostD we ssume tht mn is integerF sf one hnges the portfolio bn to bnCI then the welth t sset j should e @j A SnI hbn ; xn i bnCI D so the numer of shres j should e

@j A

@j A @j A a SnI hbn ; xn i bnCI : mnCI @j A


Sn

sf mnCI < mn then we hve to sellD nd the welth wht we got is


d @j A m@j A C S @j A a X S b@j A x@j A S hb ; x i b@j A C : n n nI n n nCI nI n nCI j aI j aI @j A @j A sf mnCI > mn then we hve to uyD nd the welth wht we py is d X

@j A

@j A

mn

d @j A m@j A C S @j A a X S hb ; x i b@j A S b@j A x@j A C : mnCI n n n nI n n nCI nI n j aI j aI d X

vet C >

H e the (xed trnstion ostD then the trnstion fee is


cn

a cn@bnCIA a C

d X j mn j

aI

@ A m@j A : nCI

RH

he portfolio seletion bnCI is selfE(nning if


d X j

aI aI

SnI bn xn

@j A @j A S

I hbn ; xn i bnCI

@j A C


d X j

SnI bn ; xn bnCI

C i @jA SnIb@njAx@njA C cn: @j A

bnCI is n dmissile portfolio if mnCI is integer for ll j nd it stis(es the selfE(nning onditionF he set of dmissile portfolios is denoted y n;d F king into ount the (xed trnstion ostD kernel sed portfolio seletion n e de(ned s followsX hoose the rdius rk;` > suh tht for ny (xed kD

por n > k

C ID introdue the expert b@k;`A y @k;`A @ bnCI a rg mx ln @Snk;`IA


X n

lim rk;` a H: 3I
k
rk;`

Pn;d

k<i n xi1 xnk+1 ik n

Xk

if the sum is nonEvoidD nd bH =d; : : : ; =d otherwiseF gomine the @k;`A fb@k;`A g s followsX let fqk;` g e elementry portfolio strtegies B n proility distriution on the set of ll pirs k; ` suh tht for ll k; `D qk;` > F he omined strtegy B then rises from weighing the elementry @k;`A portfolio strtegies fbn g suh tht the investor9s pitl eomes

a @I

bn

@k;`A ; x

cn@bAA hb ; xii

I A

@ A

Sn

qk;` Sn

@k;`A :

@IRA

k;`

Portfolio selection for proportional transaction cost

he prolem of growth optiml investment with proportionl trnstion osts ws studied y gover nd syengr PU in horse re mrketsD lso lled erodile mrketF syengr PS investigted growth optiml investment with severl ssets ssuming independent nd identilly distriuted sequene of sset returnsF he most fr rehing study ws hfer RS who onsidered the mximiztion of the expeted growth rte with severl ssets when the RI

sset returns re wrkovinF qyr( nd jd PQ extended it to lmost sure optimlityF ell these ppers ssume the knowledge of the distriutions of the mrket proessF sn this setion we hve some experiments on two empiril @dt drivenA portfolio seletionsF vet Sn denote the welth t the lose of mrket dy nD n ; ; ;D where wFlFoFgF let the investor9s initil pitl SH e I dollrF et the eginE ning of new mrket dy n D the investor sets up his new portfolioD iFeF uysGsells stoks ording to the tul portfolio vetor bnCI F huring this rerrngementD he hs to py trnstion ostD therefore t the eginning of new mrket dy n the net welth Nn in the portfolio bnCI is less thn Sn F sing the ove nottions the @grossA welth Sn t the lose of mrket dy n is

aH I P

CI

CI

Sn

a NnI H

d X

where h ; i denotes inner produtF he rte of proportionl trnstion ost @ommission ftorA levied on one sset is denoted y < c < D iFeF the sle of I dollr worth of sset i nets only c dollrsD nd similrly we tke into ount the purhse of n sset suh tht the purhse of I dollr9s worth of sset i osts c dollrsF st is not hrd to see tht gross welth Sn deomposes to the sum of the net welth nd ost the following E selfE(nning E wy

aI

b n xn

@j A @j A a N

I hbn ; xn i ;

Nn

a a

Sn

d X j

aI
j

c bn xn NnI

@j A @j A
n

A b@njCINn


d X j

aI

c bnCI Nn

@j A

b@njAx@njANnI

Sn

d X j bn

aI

@ A x@j A N

I bnCI Nn ;

@j A

or equivlently
Sn

a Nn C c

d X j bn j

aI

@ A x@j A N
n

I bnCI Nn :

@j A

hividing oth sides y Sn nd introduing rtio


wn

a Nn ; S
n

RP

H < wn < ID we get I a wn C


d X c j

aI

A b@njCIwn : hbn ; xni


b n xn

@j A @j A

@ISA

iqution @ISA is used in the sequelF ixmining this ost equtionD it turns outD tht for ritrry portfolio vetors bn D bnCI D nd return vetor xn there exists unique ost ftors wn P ; D iFeF the portfolio is self (nningF he vlue of ost ftor wn t dy n is determined y portfolio vetors bn nd bnCI s well s y return vetor xn D iFeF

H IA

wn

a w@bn; bnCI; xnA;

for some funtion wF sf we wnt to rerrnge our portfolio sustntillyD then our net welth dereses more onsiderlyD howeverD it remins positiveF xoteD lsoD tht the ost does not restrits the set of new portfolio vetorsD iFeF the optimiztion lgorithm serhes for optiml vetor bnCI within the whole simplex d F he vlue of the ost ftor rnges etween

Ic ICc

wn

I: a ID welth Sn t the A hbi ; xii :

trting with n initil welth SH nd wH losing time of the nEth mrket dy eomes
Sn

aI

a NnIhbn ; xni a wnISnIhbn ; xni a


g biI ; bi ; xiI ; xi

n Y i

aI

w b i I ; b i ; x i I

sntrodue the nottion

A a ln@w@biI; bi; xiIA hbi ; xiiA; ln@w@biI; bi; xiIA hbi ; xiiA
g biI ; bi ; xiI ; xi :

then the verge growth rte eomes

I ln Sn a I n n I a n

n X i

n X i

aI aI

yur im is to mximize the verge growth rteF RQ

sn the sequel xi will e rndom vrile nd is denoted y Xi F vet9s use the deomposition
n

I ln Sn a In C Jn;

where
In

I a n @g@biI; bi; XiI; XiA Efg@biI; bi; XiI; XiAjXiIIgA


n X i

aI

nd
Jn

I an

n X i

aI

Efg@biI ; bi ; XiI ; Xi AjXiI g: I

on the support of the distriution of XD onverges to lmost surelyF husD I the symptoti mximiztion of the verge growth rte n Sn is equivlent to the mximiztion of Jn F

In is n verge of mrtingle di'erenesD whihD under generl onditions

ln

Algorithm 1.

por trnstion ostD one my pply the portfolio b XnI n or its empiril pproximtionF por exmpleD we my pply the kernel sed logEoptiml portfolio seletion introdued y qyr(D vugosi nd din IW s followsX he(ne n in(nite rry of experts B@`A fb@`A gD where ` is positive integerF por (xed positive integer `D hoose the rdius r` > suh tht

@A

henD for n > D de(ne the expert b@`A s followsF ut

lim r` a H: 3I

bn

X @`A a rg mx ln hb ; xii bPd fi<nXkx i1 xn1 k r` g

@ITA

if the sum is nonEvoidD nd bH =d; : : : ; =d otherwiseD where kk denotes the iuliden normF hese experts re ggregted @mixedA s followsX let fq` g e proility distriution over the set of ll positive integers ` suh tht for ll `D q` > F gonsider two types of ggregtionsX

a @I

I A

rere the initil pitl SH is distriuted mong the expert E ording to the distriution fq` gD nd the expert mkes the portfolio seletion nd pys for trnstion ost individullyF sf Sn B@`A is the pitl umulted y the elementry strtegy B@`A fter n periods

aI

RR

when strting with n initil pitl SH D thenD fter period nD the investor9s welth fter period nD ggregtions with the welthX
Sn

aI

q` Sn B@`A :

@IUA

rere Sn B@`A is gin the pitl umulted y the elementry strtegy B@`A fter n periods when strting with n initil pitl SH D ut it is virtul (gureD iFeFD the experts mke no trdingD its welth is just the se of ggregtionF henD fter period nD the investor9s ggregted portfolio eomes

aI

bn

` q` Sn

I @B@`A Abn @`A ` q` SnI @B A

@`A

@IVA

woreoverD the investor9s pitl is


Sn

a SnIhbn ; xniw@bnI; bn; xnIA;

so only the ggregted portfolio pys for the trnstion ostF prom now on we onsider the optimiztion of investment with trnsE tion ostsF sf the mrket proess fXi g is stationary and rst order Markov process thenD for ny portfolio seletion fbi gD we hve tht

illy equivlent to the mximiztion of


Jn

Efg@biI ; bi ; XiI ; Xi AjXiI g I a Efln@w@biI; bi; XiIA hbi ; XiiAjXiIIg a ln w@biI; bi; XiIA C Efln hbi ; Xii jXiIIg a ln w@biI; bi; XiIA C Efln hbi ; Xii jbi; XiIg def v@b ; b ; X A; a i I i i I therefore the mximiztion of the verge growth rte I ln Sn is symptotE
n

I an

n X i

aI

v biI ; bi ; XiI :

his mximiztion is dynmi progrmming prolemF RS

Algorithm 2.
for n ! D

folioD y oneEstep optimiztion s followsX put bI

I @`A bn a rg mx
b

e my introdue suoptiml solutionD lled naive portf =d; : : : ; =dg nd

a I

Pd fi<nXkxi1 xn1 k

r`

if the sum is nonEvoidD nd bH =d; : : : ; =d otherwiseF hese elementry portfolios re mixed s in @IUA or @IVAF yviouslyD this portfolio hs no glol optimlity propertyF
` c

a @I

@ln hb ; xii C ln w@bnI; b; xnIAA ; I A

@IWA

I P Q R S T U V W IH eggregtion with welth @IUA eggregtion with portfolio @IVA

QI7 QR7 QS7 QS7 QR7 QS7 QQ7 QR7 QU7 QR7 QS7 QS7

aH

elgorithm I EPP7 EPP7 EPR7 EPQ7 EPI7 EIW7 EPH7 EIV7 EIU7 EIV7

-19% -15%

elgorithm P IV7 IH7 W7 IR7 IQ7 IQ7 IP7 V7 T7 II7

13% 17%

le SX he verge nnul yields of the individul experts for kernel strtegy nd of the ggregtions with c : F

a H HHIS

xext we present some numeril results for trnstion ost otined y pplying the kernel sed semiElogEoptiml lgorithm to the IW lrge ssets of the seond dt set s in etion QFUF he proposed empiril portfolio seletion lgorithms use n in(nite set of expertsF rere we tke (nite set of size LF sn the experiment we seleted L F ghoose the uniform distriution fq` g =L over the experts in useD nd the rdius

NYSE

aI P r` a H:HHHP d C H:HHHHP d `;

a IH

for `

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portfolioF ixperts re indexed y ` ::: in rowsF he seond olumn ontins the verge nnul yields of experts for kernel sed logEoptiml portfolio if there is no trnstion ostD nd in this se the results of the two ggregtions re the smeX F wention thtD out of the IW ssetsD wys hd the est verge nnul yieldD D soD for no trnstion ostD with kernel sed logEoptiml portfolio we hve spetulr improvementF he third nd fourth olumns ontin the verge nnul yields of experts for kernel sed logEoptiml portfolio if the ommission ftor is c : F xotie tht the growth rte of the elgorithm I is negtiveD nd the growth rte of the elgorithm P is poorD tooD it is less thn the growth rte of the est ssetD nd the results of ggregtions re di'erentF e hve got similr results for nerest neighor strtegy @fF le TAF yn the one hnd these IW ssets my e too risk verse to o'er good growth rte of the welthF yn the other hnd these results hve reveled tht the proper hndling of the trnstion ost is still n open question nd n importnt diretion of the further reserhF sf the mrket proess is (rst order wrkov nd one knows the onditionl distriutions then qyr( nd jd PQ introdued FsF optiml strtegiesD howeverD it is unknown how to onstrut their dt driven versionsF

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