TY - JOUR
T1 - Smooth monotone covariance for elliptical distributions and applications in finance
AU - Zhou, Xiaoping
AU - Malioutov, Dmitry
AU - Fabozzi, Frank J.
AU - Rachev, Svetlozar T.
PY - 2014
Y1 - 2014
N2 - Sample covariance is known to be a poor estimate when the data are scarce compared with the dimension. To reduce the estimation error, various structures are usually imposed on the covariance such as low-rank plus diagonal (factor models), banded models and sparse inverse covariances. We investigate a different non-parametric regularization method which assumes that the covariance is monotone and smooth. We study the smooth monotone covariance by analysing its performance in reducing various statistical distances and improving optimal portfolio selection. We also extend its use in non-Gaussian cases by incorporating various robust covariance estimates for elliptical distributions. Finally, we provide two empirical examples using Eurodollar futures and corporate bonds where the smooth monotone covariance improves the out-of-sample covariance prediction and portfolio optimization.
AB - Sample covariance is known to be a poor estimate when the data are scarce compared with the dimension. To reduce the estimation error, various structures are usually imposed on the covariance such as low-rank plus diagonal (factor models), banded models and sparse inverse covariances. We investigate a different non-parametric regularization method which assumes that the covariance is monotone and smooth. We study the smooth monotone covariance by analysing its performance in reducing various statistical distances and improving optimal portfolio selection. We also extend its use in non-Gaussian cases by incorporating various robust covariance estimates for elliptical distributions. Finally, we provide two empirical examples using Eurodollar futures and corporate bonds where the smooth monotone covariance improves the out-of-sample covariance prediction and portfolio optimization.
KW - Elliptical distributions
KW - Regularization
KW - Smooth monotone covariance
UR - http://www.scopus.com/inward/record.url?scp=84906057098&partnerID=8YFLogxK
U2 - 10.1080/14697688.2014.911949
DO - 10.1080/14697688.2014.911949
M3 - Article
AN - SCOPUS:84906057098
VL - 14
SP - 1555
EP - 1571
JO - Quantitative Finance
JF - Quantitative Finance
SN - 1469-7688
IS - 9
ER -