portfolio optimization example

optimization/05_portfolio_optimization.py

@@ -0,0 +1,247 @@
+# /// script
+# requires-python = ">=3.13"
+# dependencies = [
+#     "cvxpy==1.6.0",
+#     "marimo",
+#     "matplotlib==3.10.0",
+#     "numpy==2.2.2",
+#     "scipy==1.15.1",
+#     "wigglystuff==0.1.9",
+# ]
+# ///
+
+import marimo
+
+__generated_with = "0.11.2"
+app = marimo.App()
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md(r"""# Portfolio optimization""")
+    return
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md(
+        r"""
+        In this example we show how to use CVXPY to design a financial portfolio; this is called _portfolio optimization_.
+
+        In portfolio optimization we have some amount of money to invest in any of $n$ different assets.
+        We choose what fraction $w_i$ of our money to invest in each asset $i$, $i=1, \ldots, n$. The goal is to maximize return of the portfolio while minimizing risk.
+        """
+    )
+    return
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md(
+        r"""
+        ## Asset returns and risk
+
+        We will only model investments held for one period. The initial prices are $p_i > 0$. The end of period prices are $p_i^+ >0$. The asset (fractional) returns are $r_i = (p_i^+-p_i)/p_i$. The porfolio (fractional) return is $R = r^Tw$.
+
+        A common model is that $r$ is a random variable with mean ${\bf E}r = \mu$ and covariance ${\bf E{(r-\mu)(r-\mu)^T}} = \Sigma$.
+        It follows that $R$ is a random variable with ${\bf E}R = \mu^T w$ and ${\bf var}(R) = w^T\Sigma w$. In real-world applications, $\mu$ and $\Sigma$ are estimated from data and models, and $w$ is chosen using a library like CVXPY.
+
+        ${\bf E}R$ is the (mean) *return* of the portfolio. ${\bf var}(R)$ is the *risk* of the portfolio. Portfolio optimization has two competing objectives: high return and low risk.
+        """
+    )
+    return
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md(
+        r"""
+        ## Classical (Markowitz) portfolio optimization
+
+        Classical (Markowitz) portfolio optimization solves the optimization problem
+        """
+    )
+    return
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md(
+        r"""
+        $$
+        \begin{array}{ll} \text{maximize} & \mu^T w - \gamma w^T\Sigma w\\
+        \text{subject to} & {\bf 1}^T w = 1, w \geq 0,
+        \end{array}
+        $$
+        """
+    )
+    return
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md(
+        r"""
+        where $w \in {\bf R}^n$ is the optimization variable and $\gamma >0$ is a constant called the *risk aversion parameter*. The constraint $\mathbf{1}^Tw = 1$ says the portfolio weight vector must sum to 1, and $w \geq 0$ says that we can't invest a negative amount into any asset.
+
+        The objective $\mu^Tw - \gamma w^T\Sigma w$ is the *risk-adjusted return*. Varying $\gamma$ gives the optimal *risk-return trade-off*.
+        We can get the same risk-return trade-off by fixing return and minimizing risk.
+        """
+    )
+    return
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md(
+        r"""
+        ## Example
+
+        In the following code we compute and plot the optimal risk-return trade-off for $10$ assets. First we generate random problem data $\mu$ and $\Sigma$.
+        """
+    )
+    return
+
+
+@app.cell
+def _():
+    import numpy as np
+    return (np,)
+
+
+@app.cell(hide_code=True)
+def _(mo, np):
+    import wigglystuff
+
+    mu_widget = mo.ui.anywidget(
+        wigglystuff.Matrix(
+            np.array(
+                [
+                    [1.6],
+                    [0.6],
+                    [0.5],
+                    [1.1],
+                    [0.9],
+                    [2.3],
+                    [1.7],
+                    [0.7],
+                    [0.9],
+                    [0.3],
+                ]
+            )
+        )
+    )
+
+
+    mo.md(
+        rf"""
+        The value of $\mu$ is 
+
+        {mu_widget.center()}
+
+        _Try changing the entries of $\mu$ and see how the plots below change._
+        """
+    )
+    return mu_widget, wigglystuff
+
+
+@app.cell
+def _(mu_widget, np):
+    np.random.seed(1)
+    n = 10
+    mu = np.array(mu_widget.matrix)
+    Sigma = np.random.randn(n, n)
+    Sigma = Sigma.T.dot(Sigma)
+    return Sigma, mu, n
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md("""Next, we solve the problem for 100 different values of $\gamma$""")
+    return
+
+
+@app.cell
+def _(Sigma, mu, n):
+    import cvxpy as cp
+
+    w = cp.Variable(n)
+    gamma = cp.Parameter(nonneg=True)
+    ret = mu.T @ w
+    risk = cp.quad_form(w, Sigma)
+    prob = cp.Problem(cp.Maximize(ret - gamma * risk), [cp.sum(w) == 1, w >= 0])
+    return cp, gamma, prob, ret, risk, w
+
+
+@app.cell
+def _(cp, gamma, np, prob, ret, risk):
+    _SAMPLES = 100
+    risk_data = np.zeros(_SAMPLES)
+    ret_data = np.zeros(_SAMPLES)
+    gamma_vals = np.logspace(-2, 3, num=_SAMPLES)
+    for _i in range(_SAMPLES):
+        gamma.value = gamma_vals[_i]
+        prob.solve()
+        risk_data[_i] = cp.sqrt(risk).value
+        ret_data[_i] = ret.value
+    return gamma_vals, ret_data, risk_data
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md("""Plotted below are the risk return tradeoffs for two values of $\gamma$ (blue squares), and the risk return tradeoffs for investing fully in each asset (red circles)""")
+    return
+
+
+@app.cell(hide_code=True)
+def _(Sigma, cp, gamma_vals, mu, n, ret_data, risk_data):
+    import matplotlib.pyplot as plt
+
+    markers_on = [29, 40]
+    fig = plt.figure()
+    ax = fig.add_subplot(111)
+    plt.plot(risk_data, ret_data, "g-")
+    for marker in markers_on:
+        plt.plot(risk_data[marker], ret_data[marker], "bs")
+        ax.annotate(
+            "$\\gamma = %.2f$" % gamma_vals[marker],
+            xy=(risk_data[marker] + 0.08, ret_data[marker] - 0.03),
+        )
+    for _i in range(n):
+        plt.plot(cp.sqrt(Sigma[_i, _i]).value, mu[_i], "ro")
+    plt.xlabel("Standard deviation")
+    plt.ylabel("Return")
+    plt.show()
+    return ax, fig, marker, markers_on, plt
+
+
+@app.cell(hide_code=True)
+def _(mo):
+    mo.md(
+        r"""
+        We plot below the return distributions for the two risk aversion values marked on the trade-off curve.
+        Notice that the probability of a loss is near 0 for the low risk value and far above 0 for the high risk value.
+        """
+    )
+    return
+
+
+@app.cell(hide_code=True)
+def _(gamma, gamma_vals, markers_on, np, plt, prob, ret, risk):
+    import scipy.stats as spstats
+
+    plt.figure()
+    for midx, _idx in enumerate(markers_on):
+        gamma.value = gamma_vals[_idx]
+        prob.solve()
+        x = np.linspace(-2, 5, 1000)
+        plt.plot(
+            x,
+            spstats.norm.pdf(x, ret.value, risk.value),
+            label="$\\gamma = %.2f$" % gamma.value,
+        )
+    plt.xlabel("Return")
+    plt.ylabel("Density")
+    plt.legend(loc="upper right")
+    plt.show()
+    return midx, spstats, x