Machine learning applied to active fixed-income portfolio management: a Lasso logit approach.

The use of quantitative methods constitutes a standard component of the institutional investors’ portfolio management toolkit. In the last decade, several empirical studies have employed probabilistic or classification models to predict stock market excess returns, model bond ratings and default probabilities, as well as to forecast yield curves. To the authors’ knowledge, little research exists into their application to active fixed-income management. This paper contributes to filling this gap by comparing a machine learning algorithm, the Lasso logit regression, with a passive (buy-and-hold) investment strategy in the construction of a duration management model for high-grade bond portfolios, specifically focusing on US treasury bonds. Additionally, a two-step procedure is proposed, together with a simple ensemble averaging aimed at minimising the potential overfitting of traditional machine learning algorithms. A method to select thresholds that translate probabilities into signals based on conditional probability distributions is also introduced.