Recursive Portfolio Machines

Jonathan S. Fan, Bryan T. Kelly, Semyon Malamud and Yuan Zhang
Additional contact information
Jonathan S. Fan: Yale College
Bryan T. Kelly: Yale SOM; AQR Capital Management, LLC; National Bureau of Economic Research (NBER)
Semyon Malamud: Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute
Yuan Zhang: Shanghai University of Finance and Economics

No 26-36, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We introduce the Recursive Portfolio Machine (RPM), an asset-pricing framework for learning the characteristic directions most relevant for the stochastic discount factor (SDF). Our theory shows that the risk-weighted gradient outer product (RWGOP) recovers the pricing-relevant subspace of characteristic space, while its eigenvectors define principal pricing directions that rank this subspace by pricing importance. The RPM operationalizes this theory by first estimating the RWGOP and then using it within a closed-form large factor model to construct the SDF. In U.S. equity data, the RPM improves out-of-sample performance relative to benchmark models. Low-rank versions retain much of the full-rank performance, suggesting that the pricing-relevant space is effectively low-dimensional.

Keywords: asset pricing; stochastic discount factor; firm characteristics; feature learning; principal pricing directions; kernel methods (search for similar items in EconPapers)
Pages: 56 pages
Date: 2026-04
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2636

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