Robo-Advisors: Machine Learning in Trend-Following ETF Investments

Seungho Baek,Seok Hee Oh,Kwan Yong Lee,Merih Uctum

doi:10.3390/su12166399

Abstract

We examine an application of machine learning to exchange traded fund investments in the U.S. market. To find how the changes in exchange traded fund prices are associated with expected market fundamentals, we propose three parsimonious risk factors extracted from various U.S. economic and market indicators. Based on the information set including these three factors, we build a predictive support vector machine model that can detect long or short investment signals. We find that the high probability of an upward momentum from our forecasting model suggests a long exchange traded fund signal, whereas the low probability of a downward momentum indicates a short exchange traded fund signal. We further design an algorithmic trading system with the support vector machine factor model. We find that the trading system shows practically desirable and robust performances over in-sample and out-of-sample trading periods

Highlights

On 24 August 2019, CNBC (Consumer News and Business Channel)’s ETF Edge [1] reported that artificial intelligence (AI) and machine learning could be the frontier for ETFs to outperform the market
AI and machine learning technology provide significant opportunities to invest in ETF index funds
Following the literature that shows the relation between the U.S stock market indexes and financial indicators, unlike earlier machine learning ETF models that rely on the past ETF prices, we controlled for various financial indicators along with the past prices to build a predictive support vector machine (SVM) factor model

Summary

Introduction

On 24 August 2019, CNBC (Consumer News and Business Channel)’s ETF (exchange traded fund) Edge [1] reported that artificial intelligence (AI) and machine learning could be the frontier for ETFs to outperform the market. Poterba and Shoven [3] explain that ETFs are of interest to financial markets concerned with tax burdens since they allow investors to reduce the tax on investments in company stocks. This makes ETFs a more attractive option compared to the traditional equity mutual funds. According to Liew and Mayster [6], EFTs are highly liquid investment assets and funds in the financial industry Because of these advantages, ETFs are considered as a potential replacement of open-end index mutual funds and they are competing for investors in the same markets as index funds

Objectives

Methods

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Conclusion