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    Market Timing strategy through Reinforcement Learning

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    Name:
    HE_temple_0225E_14387.pdf
    Embargo:
    2023-05-19
    Size:
    1.242Mb
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    Genre
    Thesis/Dissertation
    Date
    2021
    Author
    HE, Xuezhong
    Advisor
    Mao, Connie X.
    Committee member
    Rytchkov, Oleg
    Bakshi, Xiaohui Gao
    Basu, Sudipta, 1965-
    Department
    Business Administration/Finance
    Subject
    Finance
    Extreme value theory
    Reinforcement learning
    Tail risk
    Trading strategy
    Permanent link to this record
    http://hdl.handle.net/20.500.12613/6458
    
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    DOI
    http://dx.doi.org/10.34944/dspace/6440
    Abstract
    This dissertation implements an optimal trading strategy based on the machine learning method and extreme value theory (EVT) to obtain an excess return on investments in the capital market. The trading strategy outperforms the benchmark S&P 500 index with higher returns and lower volatility through effective market timing. In addition, this dissertation starts by modeling the market tail risk using the EVT and reinforcement learning methods, distinguishing from the traditional value at risk method. In this dissertation, I used EVT to extract the characteristics of the tail risk, which are inputs for reinforcement learning. This process is proved to be effective in market timing, and the trading strategy could avoid market crash and achieve a long-term excess return. In sum, this study has several contributions. First, this study takes a new method to analyze stock price (in this dissertation, I use the S&P 500 index as a stock). I combined the EVT and reinforcement learning to study the price tail risk and predict stock crash efficiently, which is a new method for tail risk research. Thus, I can predict the stock crash or provide the probability of risk, and then, the trading strategy can be built. The second contribution is that this dissertation provides a dynamic market timing trading strategy, which can significantly outperform the market index with a lower volatility and a higher Sharpe ratio. Moreover, the dynamic trading process can provide investors an intuitive sense on the stock market and help in decision-making. Third, the success of the strategy shows that the combination of EVT and reinforcement learning can predict the stock crash very well, which is a great improvement on the extreme event study and deserves further study.
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