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arXiv · 2501.16730

Growing the Efficient Frontier on Panel Trees

Lin William Cong·Guanhao Feng·Jingyu He·Xin He
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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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Lin William Cong, Guanhao Feng, Jingyu He, Xin He. 2025-01-28. Growing the Efficient Frontier on Panel Trees. https://arxiv.org/abs/2501.16730

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