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Datacamp Python 4

This document provides an introduction to portfolio analysis and optimization in Python. It discusses modern portfolio theory and how to calculate optimal portfolios using the PyPortfolioOpt library. It covers topics like efficient frontiers, maximum Sharpe ratio portfolios, minimum volatility portfolios, and using exponentially weighted returns and downside risk measures in the optimization. The goal is to help the reader understand key concepts in portfolio analysis and practice applying the techniques in Python.

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Luca Farina
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© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
324 views

Datacamp Python 4

This document provides an introduction to portfolio analysis and optimization in Python. It discusses modern portfolio theory and how to calculate optimal portfolios using the PyPortfolioOpt library. It covers topics like efficient frontiers, maximum Sharpe ratio portfolios, minimum volatility portfolios, and using exponentially weighted returns and downside risk measures in the optimization. The goal is to help the reader understand key concepts in portfolio analysis and practice applying the techniques in Python.

Uploaded by

Luca Farina
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Modern portfolio

theory
I N T R O D U C T I O N TO P O R T F O L I O A N A LY S I S I N P Y T H O N

Charlotte Werger
Data Scientist
Creating optimal portfolios

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


What is Portfolio Optimization?
Meet Harry Markowitz

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


The optimization problem: nding optimal
weights
In words:

Minimize the portfolio variance, subject to:

The expected mean return is at least some


target return

The weights sum up to 100%

At least some weights are positive

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Varying target returns leads to the Ef cient
Frontier

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


PyPortfolioOpt for portfolio optimization
from pypfopt.efficient_frontier import EfficientFrontier
from pypfopt import risk_models
from pypfopt import expected_returns

df=pd.read_csv('portfolio.csv')
df.head(2)
XOM RRC BBY MA PFE
date
2010-01-04 54.068794 51.300568 32.524055 22.062426 13.940202
2010-01-05 54.279907 51.993038 33.349487 21.997149 13.741367

# Calculate expected annualized returns and sample covariance


mu = expected_returns.mean_historical_return(df)
Sigma = risk_models.sample_cov(df)

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Get the Ef cient Frontier and portfolio weights
# Calculate expected annualized returns and risk
mu = expected_returns.mean_historical_return(df)
Sigma = risk_models.sample_cov(df)

# Obtain the EfficientFrontier


ef = EfficientFrontier(mu, Sigma)

# Select a chosen optimal portfolio


ef.max_sharpe()

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Different optimizations
# Select the maximum Sharpe portfolio
ef.max_sharpe()

# Select an optimal return for a target risk


ef.efficient_risk(2.3)

# Select a minimal risk for a target return


ef.efficient_return(1.5)

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Calculate portfolio risk and performance
# Obtain the performance numbers
ef.portfolio_performance(verbose=True, risk_free_rate = 0.01)

Expected annual return: 21.3%


Annual volatility: 19.5%
Sharpe Ratio: 0.98

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Let's optimize a
portfolio!
I N T R O D U C T I O N TO P O R T F O L I O A N A LY S I S I N P Y T H O N
Maximum Sharpe vs.
minimum volatility
I N T R O D U C T I O N TO P O R T F O L I O A N A LY S I S I N P Y T H O N

Charlotte Werger
Data Scientist
Remember the Ef cient Frontier?

Ef cient frontier: all portfolios with an


optimal risk and return trade-off

Maximum Sharpe portfolio: the highest


Sharpe ratio on the EF

Minimum volatility portfolio: the lowest


level of risk on the EF

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Adjusting PyPortfolioOpt optimization

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Maximum Sharpe portfolio
Maximum Sharpe portfolio: the highest Sharpe ratio on the EF

from pypfopt.efficient_frontier import EfficientFrontier

# Calculate the Efficient Frontier with mu and S


ef = EfficientFrontier(mu, Sigma)
raw_weights = ef.max_sharpe()

# Get interpretable weights


cleaned_weights = ef.clean_weights()

{'GOOG': 0.01269,'AAPL': 0.09202,'FB': 0.19856,


'BABA': 0.09642,'AMZN': 0.07158,'GE': 0.02456,...}

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Maximum Sharpe portfolio
# Get performance numbers
ef.portfolio_performance(verbose=True)

Expected annual return: 33.0%


Annual volatility: 21.7%
Sharpe Ratio: 1.43

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Minimum Volatility Portfolio
Minimum volatility portfolio: the lowest level of risk on the EF

# Calculate the Efficient Frontier with mu and S


ef = EfficientFrontier(mu, Sigma)

raw_weights = ef.min_volatility()

# Get interpretable weights and performance numbers


cleaned_weights = ef.clean_weights()

{'GOOG': 0.05664, 'AAPL': 0.087, 'FB': 0.1591,


'BABA': 0.09784, 'AMZN': 0.06986, 'GE': 0.0123,...}

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Minimum Volatility Portfolio
ef.portfolio_performance(verbose=True)

Expected annual return: 17.4%


Annual volatility: 13.2%
Sharpe Ratio: 1.28

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Let's have another look at the Ef cient Frontier

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Maximum Sharpe versus Minimum Volatility

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Let's practice!
I N T R O D U C T I O N TO P O R T F O L I O A N A LY S I S I N P Y T H O N
Alternative portfolio
optimization
I N T R O D U C T I O N TO P O R T F O L I O A N A LY S I S I N P Y T H O N

Charlotte Werger
Data Scientist
Expected risk and return based on historic data

Mean historic returns, or the historic


portfolio variance are not perfect estimates of
mu and Sigma

Weights from portfolio optimization


therefore not guaranteed to work well on
future data

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Historic data

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Exponentially weighted returns

Need better measures for risk and return

Exponentially weighted risk and return


assigns more importance to the most recent
data

Exponential moving average in the graph:


most weight on t-1 observation

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Exponentially weighted covariance

The exponential covariance matrix: gives


more weight to recent data

In the graph: exponential weighted


volatility in black, follows real volatility better
than standard volatility in blue

1 Source: http://systematicinvestor.github.io/Exponentially 2 Weighted 3 Volatility 4 RCPP

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Exponentially weighted returns
from pypfopt import expected_returns

# Exponentially weighted moving average


mu_ema = expected_returns.ema_historical_return(df,
span=252, frequency=252)
print(mu_ema)

symbol
XOM 0.103030
BBY 0.394629
PFE 0.186058

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Exponentially weighted covariance
from pypfopt import risk_models

# Exponentially weighted covariance


Sigma_ew = risk_models.exp_cov(df, span=180, frequency=252)

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Using downside risk in the optimization

Remember the Sortino ratio: it uses the variance of negative returns only

PyPortfolioOpt allows you to use semicovariance in the optimization, this is a measure for
downside risk:

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Semicovariance in PyPortfolioOpt
Sigma_semi = risk_models.semicovariance(df,
benchmark=0, frequency=252)

print(Sigma_semi)

XOM BBY MA PFE


XOM 0.018939 0.008505 0.006568 0.004058
BBY 0.008505 0.016797 0.009133 0.004404
MA 0.006568 0.009133 0.018711 0.005373
PFE 0.004058 0.004404 0.005373 0.008349

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Let's practice!
I N T R O D U C T I O N TO P O R T F O L I O A N A LY S I S I N P Y T H O N
Recap
I N T R O D U C T I O N TO P O R T F O L I O A N A LY S I S I N P Y T H O N

Charlotte Werger
Data Scientist
Chapter 1: Calculating risk and return

A portfolio as a collection of weight and assets

Diversi cation

Mean returns versus cumulative returns

Variance, standard deviation, correlations and the covariance matrix

Calculating portfolio variance

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Chapter 2: Diving deep into risk measures

Annualizing returns and risk to compare over different periods

Sharpe ratio as a measured of risk adjusted returns

Skewness and Kurtosis: looking beyond mean and variance of a distribution

Maximum draw-down, downside risk and the Sortino ratio

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Chapter 3: Breaking down performance

Compare to benchmark with active weights and active returns

Investment factors: explain returns and sources of risk

Fama French 3 factor model to breakdown performance into explainable factors and alpha

Pyfolio as a portfolio analysis tool

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Chapter 4: Finding the optimal portfolio

Markowitz' portfolio optimization: ef cient frontier, maximum Sharpe and minimum volatility
portfolios

Exponentially weighted risk and return, semicovariance

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


Continued learning

Datacamp course on Portfolio Risk Management in Python

Quantopian's lecture series: https://www.quantopian.com/lectures

Learning by doing: Pyfolio and PyPortfolioOpt

INTRODUCTION TO PORTFOLIO ANALYSIS IN PYTHON


End of this course
I N T R O D U C T I O N TO P O R T F O L I O A N A LY S I S I N P Y T H O N

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