Honey, I shrunk the sample covariance matrix

Welcome to the UPF Digital Repository

Journal of Portfolio Management 30, Volume 4, 110-119, 2004
http://hdl.handle.net/10230/560
To cite or link this document: http://hdl.handle.net/10230/560
dc.contributor.author Ledoit, Olivier
dc.contributor.author Wolf, Michael
dc.contributor.other Universitat Pompeu Fabra. Departament d'Economia i Empresa
dc.date.issued 2003-06-01
dc.identifier.citation Journal of Portfolio Management 30, Volume 4, 110-119, 2004
dc.identifier.uri http://hdl.handle.net/10230/560
dc.description.abstract The central message of this paper is that nobody should be using the sample covariance matrix for the purpose of portfolio optimization. It contains estimation error of the kind most likely to perturb a mean-variance optimizer. In its place, we suggest using the matrix obtained from the sample covariance matrix through a transformation called shrinkage. This tends to pull the most extreme coefficients towards more central values, thereby systematically reducing estimation error where it matters most. Statistically, the challenge is to know the optimal shrinkage intensity, and we give the formula for that. Without changing any other step in the portfolio optimization process, we show on actual stock market data that shrinkage reduces tracking error relative to a benchmark index, and substantially increases the realized information ratio of the active portfolio manager.
dc.language.iso eng
dc.relation.ispartofseries Economics and Business Working Papers Series; 691
dc.rights L'accés als continguts d'aquest document queda condicionat a l'acceptació de les condicions d'ús establertes per la següent llicència Creative Commons
dc.rights.uri http://creativecommons.org/licenses/by-nc-nd/3.0/es/
dc.title Honey, I shrunk the sample covariance matrix
dc.type info:eu-repo/semantics/workingPaper
dc.date.modified 2014-06-03T07:14:09Z
dc.subject.keyword Finance and Accounting
dc.subject.keyword covariance matrix
dc.subject.keyword markovitz optimization
dc.subject.keyword shrinkage
dc.subject.keyword tracking error
dc.rights.accessRights info:eu-repo/semantics/openAccess


See full text
This document is licensed under a Creative Commons license:

Search


Advanced Search

Browse

My Account

Statistics