Journal of the Korean Operations Research and Management Science Society (한국경영과학회지)

The Korean Operations Research and Management Science Society (한국경영과학회)
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Development and Evaluation of a Portfolio Selection Model and Investment Algorithm utilizing a Markov Chain in the Foreign Exchange Market

외환 시장에서 마코브 체인을 활용한 포트폴리오 선정 모형과 투자 알고리즘 개발 및 성과평가

  • 최재호 (연세대학교 경영대학 경영학과) ;
  • 정종빈 (연세대학교 경영대학 경영학과) ;
  • 김성문 (연세대학교 경영대학 경영학과)
  • Received : 2014.11.24
  • Accepted : 2014.12.08
  • Published : 2015.05.31
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Abstract

In this paper, we propose a portfolio selection model utilizing a Markov chain for investing in the foreign exchange market based on market forecasts and exchange rate movement predictions. The proposed model is utilized to compute optimum investment portfolio weights for investing in margin-based markets such as the FX margin market. We further present an objective investment algorithm for applying the proposed model in real-life investments. Empirical performance of the proposed model and investment algorithm is evaluated by conducting an experiment in the FX market consisting of the 7 most traded currency pairs, for a period of 9 years, from the beginning of 2005 to the end of 2013. We compare performance with 1) the Dollar Index, 2) a 1/N Portfolio that invests the equal amount in the N target assets, and 3) the Barclay BTOP FX Index. Performance is compared in terms of cumulated returns and Sharpe ratios. The results suggest that the proposed model outperforms all benchmarks during the period of our experiment, for both performance measures. Even when compared in terms of pre- and post-financial crisis, the proposed model outperformed all other benchmarks, showing that the model based on objective data and mathematical optimization achieves superior performance empirically.

Keywords

References

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