Factor Learning Portfolio Optimization Informed by Continuous-Time Finance Models

Sinong Geng, houssam nassif, Zhaobin Kuang, Anders Max Reppen, K. Ronnie Sircar

Abstract: We study financial portfolio optimization in the presence of unknown and uncontrolled system variables referred to as stochastic factors. Existing work falls into two distinct categories: (i) reinforcement learning employs end-to-end policy learning with flexible factor representation, but does not precisely model the dynamics of asset prices or factors; (ii) continuous-time finance methods, in contrast, take advantage of explicitly modeled dynamics but pre-specify, rather than learn, factor representation. We propose FaLPO (factor learning portfolio optimization), a framework that interpolates between these two approaches. Specifically, FaLPO hinges on deep policy gradient to learn a performant investment policy that takes advantage of flexible representation for stochastic factors. Meanwhile, FaLPO also incorporates continuous-time finance models when modeling the dynamics. It uses the optimal policy functional form derived from such models and optimizes an objective that combines policy learning and model calibration. We prove the convergence of FaLPO, and provide performance guarantees via a finite-sample bound. On both synthetic and real-world portfolio optimization tasks, we observe that FaLPO outperforms five leading methods. Finally, we show that FaLPO can be extended to other decision-making problems with stochastic factors.

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