SSRN Id3177534 PDF
SSRN Id3177534 PDF
SSRN Id3177534 PDF
in 10 Minutes
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Electronic copy available at: https://ssrn.com/abstract=3177534
1. Portfolio Construction
• Most firms continue to allocate trillions of dollars using mean-variance portfolio
optimization (MVO). “The most expensive piece of beautiful math in history.”
• It is widely known that MVO underperforms the naïve allocation out-of-sample (De
Miguel et al. [2009]).
• In contrast, ML solutions outperform MVO (and 1/N) out-of-sample, with gains in
Sharpe ratio that exceed 31% (López de Prado [2016]).
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Electronic copy available at: https://ssrn.com/abstract=3177534
2. Structural Breaks
• A recurrent criticism of quantitative models is that they are “fit to fail.”
– That may be true of simple linear regression models, like the ones used in Econometric analysis.
• ML models are particular good at detecting change, even in chaotic systems.
– ML models can be designed to compute the probability that an observation belongs to previously
observed clusters.
– The goal of such models is to derive a regime switch probability, not to make a point prediction.
Once we know what are the factors at play, we can develop a theory
of how.
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5. Detection of False Investment Strategies
The y-axis displays the distribution of the maximum Sharpe ratios
(max{SR}) for a given number of trials (x-axis). A lighter color indicates a
higher probability of obtaining that result, and the dash-line indicates
the expected value.
For example, after only 1,000 independent backtests, the expected
maximum Sharpe ratio (E[max{SR}]) is 3.26, even if the true Sharpe ratio
of the strategy is zero!
Most quantitative firms invest in false discoveries.
Solution: Deflate the Sharpe ratio by the number and variance of trials.
Stats Cluster 0 Cluster 1 Cluster 2 Cluster 3
Strat Count 3265 1843 930 347 The selected strategy belongs to
aSR 1.5733 1.4907 2.0275 1.0158
SR 0.0974 0.0923 0.1255 0.0629 Cluster 2. After taking into
Skew -0.3333 -0.4520 -0.4194 0.8058 account the number and
Kurt 11.2773 6.0953 7.4035 14.2807
T 2172 2168 2174 2172 variance of trials involved in the
StartDt
EndDt
2010-01-04
2018-05-01
2010-01-04
2018-04-25
2010-01-04
2018-05-03
2010-01-04
2018-05-01
discovery, the probability that
Freq 261.0474 261.0821 261.1159 261.0474 𝑆𝑅 > 0 is virtually 1. Hence, the
sqrt(V[SR_k]) 0.0257 0.0256 0.0256 0.0257
E[max SR_k] 0.0270 0.0270 0.0270 0.0270
backtest is unlikely to be overfit.
DSR 0.9993 0.9985 1.0000 0.9558
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For Additional Details
The first wave of quantitative innovation in finance was led by Markowitz
optimization. Machine Learning is the second wave and it will touch every
aspect of finance. López de Prado’s Advances in Financial Machine Learning is
essential for readers who want to be ahead of the technology rather than
being replaced by it.
— Prof. Campbell Harvey, Duke University. Former President of the American
Finance Association.
Financial problems require very distinct machine learning solutions. Dr. López
de Prado’s book is the first one to characterize what makes standard machine
learning tools fail when applied to the field of finance, and the first one to
provide practical solutions to unique challenges faced by asset managers.
Everyone who wants to understand the future of finance should read this
book.
— Prof. Frank Fabozzi, EDHEC Business School. Editor of The Journal of
Portfolio Management.
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THANKS FOR YOUR ATTENTION!
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Bio
Dr. Marcos López de Prado is the chief executive officer of True Positive Technologies. He founded Guggenheim
Partners’ Quantitative Investment Strategies (QIS) business, where he developed high-capacity machine
learning (ML) strategies that consistently delivered superior risk-adjusted returns. After managing up to $13
billion in assets, Marcos acquired QIS and spun-out that business from Guggenheim in 2018.
Since 2010, Marcos has been a research fellow at Lawrence Berkeley National Laboratory (U.S. Department of
Energy, Office of Science). One of the top-10 most read authors in finance (SSRN's rankings), he has published
dozens of scientific articles on ML and supercomputing in the leading academic journals, and he holds multiple
international patent applications on algorithmic trading.
Marcos earned a PhD in Financial Economics (2003), a second PhD in Mathematical Finance (2011) from
Universidad Complutense de Madrid, and is a recipient of Spain's National Award for Academic Excellence
(1999). He completed his post-doctoral research at Harvard University and Cornell University, where he teaches
a Financial ML course at the School of Engineering. Marcos has an Erdős #2 and an Einstein #4 according to the
American Mathematical Society.
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Disclaimer
• The views expressed in this document are the authors’ and do not necessarily
reflect those of the organizations he is affiliated with.
• No investment decision or particular course of action is recommended by this
presentation.
• All Rights Reserved.
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