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Automated Machine Learning and Asset Pricing

Author

Listed:
  • Jerome V. Healy

    (Liverpool Business School, Liverpool John Moores University, Liverpool L3 5UG, UK)

  • Andros Gregoriou

    (Liverpool Business School, Liverpool John Moores University, Liverpool L3 5UG, UK)

  • Robert Hudson

    (Business School, University of Hull, Hull HU6 7RX, UK)

Abstract

We evaluate whether machine learning methods can better model excess portfolio returns compared to the standard regression-based strategies generally used in the finance and econometric literature. We examine 17 benchmark factor model specifications based on Expected Utility Theory and theory drawn from behavioural finance. We assess whether machine learning can identify features of the data-generating process undetected by standard methods and rank the best-performing algorithms. Our tests use 95 years of CRSP data, from 1926 to 2021, encompassing the price history of the broad US stock market. Our findings suggest that machine learning methods provide more accurate models of stock returns based on risk factors than standard regression-based methods of estimation. They also indicate that certain risk factors and combinations of risk factors may be more attractive when more appropriate account is taken of the non-linear properties of the underlying assets.

Suggested Citation

  • Jerome V. Healy & Andros Gregoriou & Robert Hudson, 2024. "Automated Machine Learning and Asset Pricing," Risks, MDPI, vol. 12(9), pages 1-12, September.
  • Handle: RePEc:gam:jrisks:v:12:y:2024:i:9:p:148-:d:1478550
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    References listed on IDEAS

    as
    1. Lintner, John, 1969. "The Aggregation of Investor's Diverse Judgments and Preferences in Purely Competitive Security Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 4(4), pages 347-400, December.
    2. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    3. Kolm, Petter N. & Tütüncü, Reha & Fabozzi, Frank J., 2014. "60 Years of portfolio optimization: Practical challenges and current trends," European Journal of Operational Research, Elsevier, vol. 234(2), pages 356-371.
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