Stochastic interpretation of universal portfolio and generalized target classes
Mariko Tsurusaki, Jun’ichi Takeuchi · 2011
We provide a new look at Cover's universal portfolio, where we define probability density functions (p.d.f.) representing wealth functions of portfolios. In this view, log wealth ratio of a portfolio sequence is equal to coding regret of its p.d.f. for the target class which consists of the p.d.f. representing constantly rebalanced portfolios (CRP). It is revealed that the p.d.f. of a CRP is a hidden Markov model (HMM) with the restriction that the latent variable's distribution is Bernoulli. Further we consider the portfolio with the generalized target class defined by extending the latent variable's distribution to a parametric model of stochastic processes. Then, we discuss the minimax log wealth ratio of the class analyzing Fisher information of the p.d.f. for portfolios, which is strictly smaller than that of the latent variable's model. Finally we propose a portfolio strategy using the Jeffreys prior of the class of p.d.f. and an efficient method to calculate causal portfolios using the Baum-Welch algorithm.