A0286
Title: Dynamic portfolio selection with sector-specific regularization
Authors: Linqi Wang - Universite catholique de Louvain (Belgium) [presenting]
Christian Hafner - UCL/CORE (Belgium)
Abstract: A new algorithm is proposed for dynamic portfolio selection that takes a sector structure into account. We consider regularization with respect to within and between sector variation of portfolio weights, additional to sparsity and transaction cost controls. Our model includes two special cases as benchmarks: a dynamic conditional correlation model with shrinkage estimation of the unconditional covariance matrix, and the equally weighted portfolio. We propose an algorithm for estimation of the model parameters and calibration of the penalty terms based on cross-validation. In an empirical study, we find that the within-sector regularization contributes significantly to the reduction of out-of-sample volatility of portfolio returns. Our model improves both the pure DCC with nonlinear shrinkage and the equally-weighted portfolio out-of-sample.
