Futuristic portfolio optimization problem: wavelet based long short-term memory

• Published in: Journal of modelling in management Vol. 19; no. 2; pp. 523 - 555
• Main Authors: Abolmakarem, Shaghayegh, Abdi, Farshid, Khalili-Damghani, Kaveh, Didehkhani, Hosein
• Format: Journal Article
• Language: English
• Published: Bradford Emerald Publishing Limited 01-02-2024; Emerald Group Publishing Limited
• Subjects: Algorithms; Artificial intelligence; Forecasting; Investments; Literature reviews; Neural networks; Optimization; Rates of return; Research methodology; Researchers; Securities markets; Stock exchanges; Stock prices; Time series; Wavelet transforms; Deep learning; Epsilon-constraint method; Wavelet transformation; Long short-term memory (LSTM); Mean-variance portfolio optimization problem
• ISSN: 1746-5664; 1746-5664; 1746-5672
• DOI: 10.1108/JM2-09-2022-0232

Purpose
This paper aims to propose an improved version of portfolio optimization model through the prediction of the future behavior of stock returns using a combined wavelet-based long short-term memory (LSTM).
Design/methodology/approach
First, data are gathered and divided into two parts, namely, “past data” and “real data.” In the second stage, the wavelet transform is proposed to decompose the stock closing price time series into a set of coefficients. The derived coefficients are taken as an input to the LSTM model to predict the stock closing price time series and the “future data” is created. In the third stage, the mean-variance portfolio optimization problem (MVPOP) has iteratively been run using the “past,” “future” and “real” data sets. The epsilon-constraint method is adapted to generate the Pareto front for all three runes of MVPOP.
Findings
The real daily stock closing price time series of six stocks from the FTSE 100 between January 1, 2000, and December 30, 2020, is used to check the applicability and efficacy of the proposed approach. The comparisons of “future,” “past” and “real” Pareto fronts showed that the “future” Pareto front is closer to the “real” Pareto front. This demonstrates the efficacy and applicability of proposed approach.
Originality/value
Most of the classic Markowitz-based portfolio optimization models used past information to estimate the associated parameters of the stocks. This study revealed that the prediction of the future behavior of stock returns using a combined wavelet-based LSTM improved the performance of the portfolio.