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Large dynamic covariance matrices


Engle, Robert F; Ledoit, Olivier; Wolf, Michael (2017). Large dynamic covariance matrices. Working paper series / Department of Economics 231, University of Zurich.

Abstract

Second moments of asset returns are important for risk management and portfolio selection. The problem of estimating second moments can be approached from two angles: time series and the cross-section. In time series, the key is to account for conditional heteroskedasticity; a favored model is Dynamic Conditional Correlation (DCC), derived from the ARCH/GARCH family started by Engle (1982). In the cross-section, the key is to correct in-sample biases of sample covariance matrix eigenvalues; a favored model is nonlinear shrinkage, derived from Random Matrix Theory (RMT). The present paper marries these two strands of literature in order to deliver improved estimation of large dynamic covariance matrices.

Abstract

Second moments of asset returns are important for risk management and portfolio selection. The problem of estimating second moments can be approached from two angles: time series and the cross-section. In time series, the key is to account for conditional heteroskedasticity; a favored model is Dynamic Conditional Correlation (DCC), derived from the ARCH/GARCH family started by Engle (1982). In the cross-section, the key is to correct in-sample biases of sample covariance matrix eigenvalues; a favored model is nonlinear shrinkage, derived from Random Matrix Theory (RMT). The present paper marries these two strands of literature in order to deliver improved estimation of large dynamic covariance matrices.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Department of Economics
Dewey Decimal Classification:330 Economics
JEL Classification:C13, C58, G11
Uncontrolled Keywords:Composite likelihood, dynamic conditional correlations, GARCH, Markowitz portfolio selection, nonlinear shrinkage
Language:English
Date:April 2017
Deposited On:10 Aug 2016 13:10
Last Modified:08 Dec 2017 20:09
Series Name:Working paper series / Department of Economics
Number of Pages:42
ISSN:1664-7041
Additional Information:Revised version
Official URL:http://www.econ.uzh.ch/static/wp/econwp231.pdf
Related URLs:http://www.econ.uzh.ch/static/workingpapers.php

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Download PDF  'Large dynamic covariance matrices'.
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Content: Published Version
Filetype: PDF (Revised version April 2017)
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