TPLVM: Portfolio Construction by Student’s <i>t</i>-Process Latent Variable Model

• Main Authors: Yusuke Uchiyama, Kei Nakagawa
• Format: Article
• Language: English
• Published: MDPI AG 2020-03-01
• Series: Mathematics
• Subjects: student’s t-process; latent variable model; factor model; portfolio theory; global stock markets
• Online Access: https://www.mdpi.com/2227-7390/8/3/449

Optimal asset allocation is a key topic in modern finance theory. To realize the optimal asset allocation on investor&#8217;s risk aversion, various portfolio construction methods have been proposed. Recently, the applications of machine learning are rapidly growing in the area of finance. In this article, we propose the Student&#8217;s <i>t</i>-process latent variable model (TPLVM) to describe non-Gaussian fluctuations of financial timeseries by lower dimensional latent variables. Subsequently, we apply the TPLVM to portfolio construction as an alternative of existing nonlinear factor models. To test the performance of the proposed method, we construct minimum-variance portfolios of global stock market indices based on the TPLVM or Gaussian process latent variable model. By comparing these portfolios, we confirm the proposed portfolio outperforms that of the existing Gaussian process latent variable model.