# Parametric portfolio policy with momentum-based sentiment trading strategy

## TL;DR

This paper introduces a new portfolio strategy that uses market sentiment and momentum to improve investment performance and risk-adjusted returns.

## Contribution

A parametric portfolio policy incorporating momentum-based sentiment characteristic vectors is proposed to enhance traditional asset allocation.

## Key findings

- The proposed model outperforms the minimum-variance benchmark, especially during financial crises.
- Incorporating sentiment-driven momentum leads to better risk-adjusted returns and asset allocation.
- The model accounts for transaction costs and is evaluated over a 15-year period.

## Abstract

To enhance the effectiveness of the conventional mean-variance portfolio model, this study introduces a parametric portfolio policy that incorporates a momentum-based sentiment characteristic vector. This vector enables the identification of outperforming assets by capturing both historical returns and market sentiment. Drawing on a decade of rebalancing data from the S&P 500 and Dow Jones 30 constituent stocks, the proposed model optimizes the interrelationships among portfolio holdings, a benchmark portfolio, and the constructed characteristic vectors. In contrast to conventional static back testing approaches, the proposed model accounts for transaction costs and is evaluated over a 15-year investment horizon. Empirical results demonstrate that the proposed model significantly outperforms the benchmark, particularly the minimum-variance model that does not incorporate sentiment-driven parametric adjustments. During periods of financial crisis, the model selects sentiment-based momentum more frequently, leading to differing asset allocations and potentially higher utility for investors. The sentiment-augmented momentum strategy exhibits superior performance compared to the conventional mean-variance approach. The findings underscore the importance of integrating market sentiment into characteristic vector construction, affirming the value of parametric portfolio policies in improving asset allocation and risk-adjusted returns.