AI-Enhanced Adaptive Portfolio Optimization: Beyond the Markowitz Model

Abstract

This thesis examines the progression of portfolio optimization techniques from traditional (Markowitz and CAPM) to much more computationally advanced techniques such as Machine Learning and LLMs. Using a 15 year dataset of daily S&P500 returns, we show that Long Short-Term Memory (LSTMs) excel at capturing much shorter-term return forecasting compared to Deep Neural Networks (DNNs) which excel at discerning complex, otherwise invisible patterns in the long term and map straight from input data to asset weights. Both approaches surpass classical benchmarks in risk-adjusted performance. Lastly, we introduce a Large Language Model (LLM)–based simulator, demonstrating how ChatGPT can effectively synthesize (e.g., news headline sentiment, policy announcements) into allocation decisions. Our findings highlight the promising future of prompt engineering as well as LLM’s promising ability to combine numerical and textual insight into, potentially, better understood portfolio strategies.