Vector-Quantized Discrete Latent Factors Meet Financial Priors: Dynamic Cross-Sectional Stock Ranking Prediction for Portfolio Construction
Authors: Namhyoung Kim, Jae Wook Song
Organizations: RiskX · Hanyang University
Abstract
Predicting cross-sectional stock returns is challenging due to low signal-to-noise ratios and evolving market regimes. Classical factor models offer interpretability but limited flexibility, while deep learning models achieve strong performance yet often underutilize financial priors. We address this gap with PRISM-VQ (PRior-Informed Stock Model with Vector Quantization), a dynamic factor framework that integrates expert prior factors, vector-quantized discrete latent factors learned from cross-sectional structure, and a structure-conditioned Mixture-of-Experts to generate time-varying factor loadings. Vector quantization acts as an information bottleneck that suppresses noise while capturing robust market structure, with discrete codes serving both as latent factors and as routing signals for temporal expert specialization. Experiments on CSI 300 and S&P 500 show consistent improvements in cross-sectional return prediction and portfolio performance over strong baselines while preserving interpretability. Our code is available at https://github.com/finxlab/PRISM-VQ.
Cross-sectional stock ranking is a fundamental task in quantitative investment, relying on both temporal modeling of individual stocks and the capture of inter-stock dependencies. While existing deep learning models leverage graph-based approaches to enhance ranking accuracy by propagating information over relational graphs, they suffer from a key challenge: crosstalk, namely unintended information interference across predictive factors. We identify two forms of crosstalk: temporal-scale crosstalk, where trends, fluctuations, and shocks are entangled in a shared representation and non-transferable local patterns contaminate cross-stock learning; and structural crosstalk, where heterogeneous relations are indiscriminately fused and relation-specific predictive signals are obscured. To address both issues, we propose the Anti-CrossTalk (ACT) framework for cross-sectional stock ranking via temporal disentanglement and structural purification. Specifically, ACT first decomposes each stock sequence into trend, fluctuation, and shock components, then extracts component-specific information through dedicated branches, which effectively decouples non-transferable local patterns. ACT further introduces a Progressive Structural Purification Encoder to sequentially purify structural crosstalk on the trend component after mitigating temporal-scale crosstalk. An adaptive fusion module finally integrates all branch representations for ranking. Experiments on CSI300 and CSI500 demonstrate that ACT achieves state-of-the-art ranking accuracy and superior portfolio performance, with improvements of up to 74.25% on the CSI300 dataset.
We show that a deep neural network (DNN) trained to construct a stochastic discount factor (SDF) admits an additive decomposition separating nonlinear characteristic discovery from the pricing rule that aggregates them. This decomposition yields a linear factor representation governed by the Portfolio Tangent Kernel (PTK), which summarizes the network's learned features. In population, the implied SDF converges to a ridge-regularized version of the true SDF, with the degree of regularization determined by spectral complexity. Empirically, using U.S. equity data, the PTK representation delivers economically and statistically significant performance gains, while rising spectral complexity imposes tighter limits on finite-sample pricing.
We present an interpretable machine learning pipeline to decompose Cross-Sectional Equity Return Predictability into auditable factor contribution. We apply an XGBoost model with TreeSHAP attribution and conduct stress testing on 3632 Chinese A-share stocks from 2009 until 2019. Using 60-month, rolling windows over 55 months of out-of-sample data, XGBoost obtains a mean AUC of 0.547 and +2.38%/month (Newey-West t = 5.94; Annualized Sharpe 2.23) long-short spread for the top vs bottom quintiles. This alpha is persistent after adjusting for the Carhart four-factor model (+2.31%/month; t = 7.48). SHAP Decomposition indicates that behavioral signals (turnover and momentum) account for 58.2% of predictive attribution compared to 10.7% for valuation ratios, on average, across 55 industry groups. Ablation analysis serves to cross-validate this ranking and provides evidence that SHAP and ablation diverge in a manner that highlights feature substitutability structure that is largely invisible to either method used in isolation.