Growing the Efficient Frontier on Panel Trees

• URL: http://arxiv.org/abs/2501.16730v2
• Date: Tue, 04 Feb 2025 14:00:31 GMT
• Title: Growing the Efficient Frontier on Panel Trees
• Authors: Lin William Cong, Guanhao Feng, Jingyu He, Xin He,
• Abstract summary: We introduce a new class of tree-based models, P-Trees, for analyzing individual asset returns. P-Trees construct test assets that significantly advance the efficient frontier compared to commonly used test assets, with alphas unexplained by benchmark pricing models.
• Score: 15.665937719018444
• License:
• 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.

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