Maximally Machine-Learnable Portfolios

Philippe Goulet Coulombe and Maximilian Gobel
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Maximilian Gobel: Bocconi University

No 23-01, Working Papers from Chair in macroeconomics and forecasting, University of Quebec in Montreal's School of Management

Abstract: When it comes to stock returns, any form of predictability can bolster risk-adjusted profitability. We develop a collaborative machine learning algorithm that optimizes portfolio weights so that the resulting synthetic security is maximally predictable. Precisely, we introduce MACE, a multivariate extension of Alternating Conditional Expectations that achieves the aforementioned goal by wielding a Random Forest on one side of the equation, and a constrained Ridge Regression on the other. There are two key improvements with respect to Lo and MacKinlay original maximally predictable portfolio approach. First, it accommodates for any (nonlinear) forecasting algorithm and predictor set. Second, it handles large portfolios. We conduct exercises at the daily and monthly frequency and report significant increases in predictability and profitability using very little conditioning information. Interestingly, predictability is found in bad as well as good times, and MACE successfully navigates the debacle of 2022.

Pages: 46 pages
Date: 2023-04, Revised 2023-04
New Economics Papers: this item is included in nep-big, nep-cmp, nep-des and nep-fmk
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Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Maximally Machine-Learnable Portfolios (2024)
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