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Growing the efficient frontier on panel trees

Author

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  • Cong, Lin William
  • Feng, Guanhao
  • He, Jingyu
  • He, Xin

Abstract

We introduce a new class of tree-based models, P-Trees, for analyzing (unbalanced) panel of individual asset returns, generalizing high-dimensional sorting with economic guidance and interpretability. Under the mean–variance efficient framework, P-Trees construct test assets that significantly advance the efficient frontier compared to commonly used test assets, with alphas unexplained by benchmark pricing models. P-Tree tangency portfolios also constitute traded factors, recovering the pricing kernel and outperforming popular observable and latent factor models for investments and cross-sectional pricing. Finally, P-Trees capture the complexity of asset returns with sparsity, achieving out-of-sample Sharpe ratios close to those attained only by over-parameterized large models.

Suggested Citation

  • Cong, Lin William & Feng, Guanhao & He, Jingyu & He, Xin, 2025. "Growing the efficient frontier on panel trees," Journal of Financial Economics, Elsevier, vol. 167(C).
  • Handle: RePEc:eee:jfinec:v:167:y:2025:i:c:s0304405x25000327
    DOI: 10.1016/j.jfineco.2025.104024
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    More about this item

    Keywords

    Decision tree; Factors; Generative models; Interpretable AI; Test assets;
    All these keywords.

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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