Portfolio modeling, analysis and management

A systematic top down approach to minimize risk and maximize the profits of an investment over a given period of time is proposed. Macroeconomic factors such as Gross Domestic Product (GDP), Consumer Price Index (CPI), Outstanding Consumer Credit, Industrial Production Index, Money Supply (MS), Unemployment Rate, and Ten-Year Treasury are used to predict/estimate asset (sector ETF`s) returns. Fundamental ratios of individual stocks are used to predict the stock returns. An a priori known cash-flow sequence is assumed available for investment. Given the importance of sector performance on stock performance, sector based Exchange Traded Funds (ETFs) for the S&P; and Dow Jones are considered and wealth is allocated. Mean variance optimization with risk and return constraints are used to distribute the wealth in individual sectors among the selected stocks. The results presented should be viewed as providing an outer control/decision loop generating sector target allocations that will ultimately drive an inner control/decision loop focusing on stock selection. Receding horizon control (RHC) ideas are exploited to pose and solve two relevant constrained optimization problems. First, the classic problem of wealth maximization subject to risk constraints (as measured by a metric on the covariance matrices) is considered. Special consideration is given to an optimization problem that attempts to minimize the peak risk over the prediction horizon, while trying to track a wealth objective. It is concluded that this approach may be particularly beneficial during downturns - appreciably limiting downside during downturns while providing most of the upside during upturns. Investment in stocks during upturns and in sector ETF`s during downturns is profitable.