TY - JOUR
T1 - An adaptive portfolio trading system
T2 - A risk-return portfolio optimization using recurrent reinforcement learning with expected maximum drawdown
AU - Almahdi, Saud
AU - Yang, Steve Y.
N1 - Publisher Copyright:
© 2017 Elsevier Ltd
PY - 2017/11/30
Y1 - 2017/11/30
N2 - Dynamic control theory has long been used in solving optimal asset allocation problems, and a number of trading decision systems based on reinforcement learning methods have been applied in asset allocation and portfolio rebalancing. In this paper, we extend the existing work in recurrent reinforcement learning (RRL) and build an optimal variable weight portfolio allocation under a coherent downside risk measure, the expected maximum drawdown, E(MDD). In particular, we propose a recurrent reinforcement learning method, with a coherent risk adjusted performance objective function, the Calmar ratio, to obtain both buy and sell signals and asset allocation weights. Using a portfolio consisting of the most frequently traded exchange-traded funds, we show that the expected maximum drawdown risk based objective function yields superior return performance compared to previously proposed RRL objective functions (i.e. the Sharpe ratio and the Sterling ratio), and that variable weight RRL long/short portfolios outperform equal weight RRL long/short portfolios under different transaction cost scenarios. We further propose an adaptive E(MDD) risk based RRL portfolio rebalancing decision system with a transaction cost and market condition stop-loss retraining mechanism, and we show that the proposed portfolio trading system responds to transaction cost effects better and outperforms hedge fund benchmarks consistently.
AB - Dynamic control theory has long been used in solving optimal asset allocation problems, and a number of trading decision systems based on reinforcement learning methods have been applied in asset allocation and portfolio rebalancing. In this paper, we extend the existing work in recurrent reinforcement learning (RRL) and build an optimal variable weight portfolio allocation under a coherent downside risk measure, the expected maximum drawdown, E(MDD). In particular, we propose a recurrent reinforcement learning method, with a coherent risk adjusted performance objective function, the Calmar ratio, to obtain both buy and sell signals and asset allocation weights. Using a portfolio consisting of the most frequently traded exchange-traded funds, we show that the expected maximum drawdown risk based objective function yields superior return performance compared to previously proposed RRL objective functions (i.e. the Sharpe ratio and the Sterling ratio), and that variable weight RRL long/short portfolios outperform equal weight RRL long/short portfolios under different transaction cost scenarios. We further propose an adaptive E(MDD) risk based RRL portfolio rebalancing decision system with a transaction cost and market condition stop-loss retraining mechanism, and we show that the proposed portfolio trading system responds to transaction cost effects better and outperforms hedge fund benchmarks consistently.
KW - Downside risk
KW - Expected maximum drawdown
KW - Optimal portfolio rebalancing
KW - Recurrent reinforcement learning
UR - http://www.scopus.com/inward/record.url?scp=85021098357&partnerID=8YFLogxK
UR - http://www.scopus.com/inward/citedby.url?scp=85021098357&partnerID=8YFLogxK
U2 - 10.1016/j.eswa.2017.06.023
DO - 10.1016/j.eswa.2017.06.023
M3 - Article
AN - SCOPUS:85021098357
SN - 0957-4174
VL - 87
SP - 267
EP - 279
JO - Expert Systems with Applications
JF - Expert Systems with Applications
ER -