Diffolio: A Diffusion Model for Multivariate Probabilistic Financial Time-Series Forecasting and Portfolio Construction

TL;DR

Diffolio is a novel diffusion model that improves multivariate financial time-series forecasting and portfolio construction by capturing complex dependencies and correlations, leading to better predictive and economic outcomes.

Contribution

We introduce Diffolio, a diffusion-based approach with hierarchical attention and correlation regularization, enhancing forecast accuracy and portfolio performance over existing methods.

Findings

Diffolio outperforms baselines in forecasting accuracy.

Portfolios from Diffolio's forecasts achieve higher Sharpe ratios.

Diffolio demonstrates superior economic value in portfolio construction.

Abstract

Probabilistic forecasting is crucial in multivariate financial time-series for constructing efficient portfolios that account for complex cross-sectional dependencies. In this paper, we propose Diffolio, a diffusion model designed for multivariate financial time-series forecasting and portfolio construction. Diffolio employs a denoising network with a hierarchical attention architecture, comprising both asset-level and market-level layers. Furthermore, to better reflect cross-sectional correlations, we introduce a correlation-guided regularizer informed by a stable estimate of the target correlation matrix. This structure effectively extracts salient features not only from historical returns but also from asset-specific and systematic covariates, significantly enhancing the performance of forecasts and portfolios. Experimental results on the daily excess returns of 12 industry portfolios show that Diffolio outperforms various probabilistic forecasting baselines in multivariate forecasting accuracy and portfolio performance. Moreover, in portfolio experiments, portfolios constructed from Diffolio's forecasts show consistently robust performance, thereby outperforming those from benchmarks by achieving higher Sharpe ratios for the mean-variance tangency portfolio and higher certainty equivalents for the growth-optimal portfolio. These results demonstrate the superiority of our proposed Diffolio in terms of not only statistical accuracy but also economic significance.