Work

Growing the efficient frontier on panel trees

Year: 2025

Type: article

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.

Source: Journal of Financial Economics

DOI: 10.1016/j.jfineco.2025.104024

Authors: Lin William Cong, Guanhao Feng, Jingyu He, Xin He

Institutions: Cornell University, Fudan University, City University of Hong Kong, University of Science and Technology of China

Language: English

Topic: Financial Markets and Investment Strategies

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: hybrid

Estimated APC paid: $4,740

Funders: National Natural Science Foundation of China, Inquire Europe