Sparse Index Tracking: Simultaneous Asset Selection and Capital Allocation via $\ell_0$-Constrained Portfolio
This work addresses the challenge of reducing transaction costs and avoiding illiquid assets in passive portfolio management, though it appears incremental by improving parameter tuning over existing methods.
The paper tackled the problem of sparse index tracking in portfolio management by proposing a new formulation using an ℓ0-norm constraint to easily control the number of assets, and demonstrated its effectiveness on S&P500 and Russell3000 datasets.
Sparse index tracking is a prominent passive portfolio management strategy that constructs a sparse portfolio to track a financial index. A sparse portfolio is preferable to a full portfolio in terms of reducing transaction costs and avoiding illiquid assets. To achieve portfolio sparsity, conventional studies have utilized $\ell_p$-norm regularizations as a continuous surrogate of the $\ell_0$-norm regularization. Although these formulations can construct sparse portfolios, their practical application is challenging due to the intricate and time-consuming process of tuning parameters to define the precise upper limit of assets in the portfolio. In this paper, we propose a new problem formulation of sparse index tracking using an $\ell_0$-norm constraint that enables easy control of the upper bound on the number of assets in the portfolio. Moreover, our approach offers a choice between constraints on portfolio and turnover sparsity, further reducing transaction costs by limiting asset updates at each rebalancing interval. Furthermore, we develop an efficient algorithm for solving this problem based on a primal-dual splitting method. Finally, we illustrate the effectiveness of the proposed method through experiments on the S&P500 and Russell3000 index datasets.