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Machine Learning Portfolio Allocation

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  • Michael Pinelis
  • David Ruppert

Abstract

We find economically and statistically significant gains when using machine learning for portfolio allocation between the market index and risk-free asset. Optimal portfolio rules for time-varying expected returns and volatility are implemented with two Random Forest models. One model is employed in forecasting the sign probabilities of the excess return with payout yields. The second is used to construct an optimized volatility estimate. Reward-risk timing with machine learning provides substantial improvements over the buy-and-hold in utility, risk-adjusted returns, and maximum drawdowns. This paper presents a new theoretical basis and unifying framework for machine learning applied to both return- and volatility-timing.

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  • Michael Pinelis & David Ruppert, 2020. "Machine Learning Portfolio Allocation," Papers 2003.00656, arXiv.org, revised Nov 2021.
    • Handle: RePEc:arx:papers:2003.00656
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