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Finance With Python and MPT

The document discusses using machine learning techniques for modern portfolio theory and efficient frontiers. It generates random portfolio weights and calculates returns and volatility to plot the efficient frontier. Features and targets are created from the portfolio data to train a random forest regressor model to predict optimal weights. Hypothetical backtesting shows the model outperforms buying and holding QQQ.

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99 views31 pages

Finance With Python and MPT

The document discusses using machine learning techniques for modern portfolio theory and efficient frontiers. It generates random portfolio weights and calculates returns and volatility to plot the efficient frontier. Features and targets are created from the portfolio data to train a random forest regressor model to predict optimal weights. Hypothetical backtesting shows the model outperforms buying and holding QQQ.

Uploaded by

ravinyse
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
Download as pdf or txt
Download as pdf or txt
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DataCamp Machine Learning for Finance in Python

MACHINE LEARNING FOR FINANCE IN PYTHON

Modern portfolio theory


(MPT); efficient frontiers

Nathan George
Data Science Professor
DataCamp Machine Learning for Finance in Python
DataCamp Machine Learning for Finance in Python

Joining data
stocks = ['AMD', 'CHK', 'QQQ']
full_df = pd.concat([amd_df, chk_df, qqq_df], axis=1).dropna()
full_df.head()

AMD CHK QQQ


Date
1999-03-10 8.690 0.904417 45.479603
1999-03-11 8.500 0.951617 45.702324
1999-03-12 8.250 0.951617 44.588720
1999-03-15 8.155 0.951617 45.880501
1999-03-16 8.500 0.951617 46.281398
DataCamp Machine Learning for Finance in Python

Calculating returns
# calculate daily returns of stocks
returns_daily = full_df.pct_change()

# resample the full dataframe to monthly timeframe


monthly_df = full_df.resample('BMS').first()

# calculate monthly returns of the stocks


returns_monthly = monthly_df.pct_change().dropna()

print(returns_monthly.tail())

AMD CHK QQQ


Date
2018-01-01 0.023299 0.002445 0.028022
2018-02-01 0.206740 -0.156098 0.059751
2018-03-01 -0.101887 -0.190751 -0.020719
2018-04-02 -0.199160 0.060714 -0.052971
2018-05-01 0.167891 0.003367 0.046749
DataCamp Machine Learning for Finance in Python

Covariances
# daily covariance of stocks (for each monthly period)
covariances = {}
for i in returns_monthly.index:
rtd_idx = returns_daily.index
# mask daily returns for each month (and year) and calculate covariance
mask = (rtd_idx.month == i.month) & (rtd_idx.year == i.year)
covariances[i] = returns_daily[mask].cov()

print(covariances[i])

AMD CHK QQQ


AMD 0.000257 0.000177 0.000068
CHK 0.000177 0.002057 0.000108
QQQ 0.000068 0.000108 0.000051
DataCamp Machine Learning for Finance in Python

Generating portfolio weights


for date in covariances.keys():
cov = covariances[date]
for single_portfolio in range(5000):
weights = np.random.random(3)
weights /= np.sum(weights)
DataCamp Machine Learning for Finance in Python

Calculating returns and volatility


portfolio_returns, portfolio_volatility, portfolio_weights = {}, {}, {}

# get portfolio performances at each month


for date in covariances.keys():
cov = covariances[date]
for single_portfolio in range(5000):
weights = np.random.random(3)
weights /= np.sum(weights)

returns = np.dot(weights, returns_monthly.loc[date])


volatility = np.sqrt(np.dot(weights.T, np.dot(cov, weights)))

portfolio_returns.setdefault(date, []).append(returns)
portfolio_volatility.setdefault(date, []).append(volatility)
portfolio_weights.setdefault(date, []).append(weights)
DataCamp Machine Learning for Finance in Python

Plotting the efficient frontier


date = sorted(covariances.keys())[-1]

# plot efficient frontier


plt.scatter(x=portfolio_volatility[date],
y=portfolio_returns[date],
alpha=0.5)
plt.xlabel('Volatility')
plt.ylabel('Returns')
plt.show()
DataCamp Machine Learning for Finance in Python

MACHINE LEARNING FOR FINANCE IN PYTHON

Calculate MPT portfolios!


DataCamp Machine Learning for Finance in Python

MACHINE LEARNING FOR FINANCE IN PYTHON

Sharpe ratios; features and


targets

Nathan George
Data Science Professor
DataCamp Machine Learning for Finance in Python
DataCamp Machine Learning for Finance in Python
DataCamp Machine Learning for Finance in Python
DataCamp Machine Learning for Finance in Python

Getting our Sharpe ratios


# empty dictionaries for sharpe ratios and best sharpe indexes by date
sharpe_ratio, max_sharpe_idxs = {}, {}

# loop through dates and get sharpe ratio for each portfolio
for date in portfolio_returns.keys():
for i, ret in enumerate(portfolio_returns[date]):
volatility = portfolio_volatility[date][i]
sharpe_ratio.setdefault(date, []).append(ret / volatility)

# get the index of the best sharpe ratio for each date
max_sharpe_idxs[date] = np.argmax(sharpe_ratio[date])
DataCamp Machine Learning for Finance in Python

Create features
# calculate exponentially-weighted moving average of daily returns
ewma_daily = returns_daily.ewm(span=30).mean()

# resample daily returns to first business day of the month


ewma_monthly = ewma_daily.resample('BMS').first()

# shift ewma 1 month forward


ewma_monthly = ewma_monthly.shift(1).dropna()
DataCamp Machine Learning for Finance in Python

Calculate features and targets


targets, features = [], []

# create features from price history and targets as ideal portfolio


for date, ewma in ewma_monthly.iterrows():
# get the index of the best sharpe ratio
best_idx = max_sharpe_idxs[date]
targets.append(portfolio_weights[date][best_idx])
features.append(ewma)

targets = np.array(targets)
features = np.array(features)
DataCamp Machine Learning for Finance in Python

Re-plot efficient frontier


# latest date
date = sorted(covariances.keys())[-1]

cur_returns = portfolio_returns[date]
cur_volatility = portfolio_volatility[date]

plt.scatter(x=cur_volatility,
y=cur_returns,
alpha=0.1,
color='blue')

best_idx = max_sharpe_idxs[date]

plt.scatter(cur_volatility[best_idx],
cur_returns[best_idx],
marker='x',
color='orange')

plt.xlabel('Volatility')
plt.ylabel('Returns')
plt.show()
DataCamp Machine Learning for Finance in Python
DataCamp Machine Learning for Finance in Python

MACHINE LEARNING FOR FINANCE IN PYTHON

Get Sharpe!
DataCamp Machine Learning for Finance in Python

MACHINE LEARNING FOR FINANCE IN PYTHON

Machine learning for MPT

Nathan George
Data Science Professor
DataCamp Machine Learning for Finance in Python

Make train and test sets


# make train and test features
train_size = int(0.8 * features.shape[0])
train_features = features[:train_size]
train_targets = targets[:train_size]

test_features = features[train_size:]
test_targets = targets[train_size:]

print(features.shape)

(230, 3)
DataCamp Machine Learning for Finance in Python

Fit the model


from sklearn.ensemble import RandomForestRegressor

# fit the model and check scores on train and test


rfr = RandomForestRegressor(n_estimators=300, random_state=42)
rfr.fit(train_features, train_targets)

print(rfr.score(train_features, train_targets))
print(rfr.score(test_features, test_targets))

0.8382262317599827
0.09504859048985377
DataCamp Machine Learning for Finance in Python

Evaluate the model's performance


# get predictions from model on train and test
test_predictions = rfr.predict(test_features)

# calculate and plot returns from our RF predictions and the QQQ returns
test_returns = np.sum(returns_monthly.iloc[train_size:] * test_predictions,
axis=1)

plt.plot(test_returns, label='algo')
plt.plot(returns_monthly['QQQ'].iloc[train_size:], label='QQQ')
plt.legend()
plt.show()
DataCamp Machine Learning for Finance in Python
DataCamp Machine Learning for Finance in Python

Calculate hypothetical portfolio


cash = 1000
algo_cash = [cash]

for r in test_returns:
cash *= 1 + r
algo_cash.append(cash)

# calculate performance for QQQ


cash = 1000 # reset cash amount
qqq_cash = [cash]
for r in returns_monthly['QQQ'].iloc[train_size:]:
cash *= 1 + r
qqq_cash.append(cash)

print('algo returns:', (algo_cash[-1] - algo_cash[0]) / algo_cash[0])


print('QQQ returns:', (qqq_cash[-1] - qqq_cash[0]) / qqq_cash[0])

algo returns: 0.5009443507049591


QQQ returns: 0.5186775933696601
DataCamp Machine Learning for Finance in Python

Plot the results


plt.plot(algo_cash, label='algo')
plt.plot(qqq_cash, label='QQQ')
plt.ylabel('$')
plt.legend() # show the legend
plt.show()
DataCamp Machine Learning for Finance in Python

MACHINE LEARNING FOR FINANCE IN PYTHON

Train your model!


DataCamp Machine Learning for Finance in Python

MACHINE LEARNING FOR FINANCE IN PYTHON

Final thoughts

Nathan George
Data Science Professor
DataCamp Machine Learning for Finance in Python

Toy examples

Tools for bigger data:

Python 3 multiprocessing
Dask
Spark
AWS or other cloud solutions
DataCamp Machine Learning for Finance in Python

Get more and better data

Data in this course:

From Quandl.com/EOD (free subset available)

Alternative and other data:

satellite images
sentiment analysis (e.g. PsychSignal)
analyst predictions
fundamentals data
DataCamp Machine Learning for Finance in Python

MACHINE LEARNING FOR FINANCE IN PYTHON

Be careful, and Godspeed!

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