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Type | Journal Article |
Scope | Discipline-based scholarship |
Title | Factor models for portfolio selection in large dimensions: the good, the better and the ugly |
Organization Unit | |
Authors |
|
Item Subtype | Original Work |
Refereed | Yes |
Status | Published in final form |
Language |
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Journal Title | Journal of Financial Econometrics |
Publisher | Oxford University Press |
Geographical Reach | international |
ISSN | 1479-8409 |
Volume | 19 |
Number | 2 |
Page Range | 236 - 257 |
Date | 2021 |
Abstract Text | This paper injects factor structure into the estimation of time-varying, large-dimensional covariance matrices of stock returns. Existing factor models struggle to model the covariance matrix of residuals in the presence of time-varying conditional heteroskedasticity in large universes. Conversely, rotation-equivariant estimators of large-dimensional time-varying covariance matrices forsake directional information embedded in market-wide risk factors. We introduce a new covariance matrix estimator that blends factor structure with time-varying conditional heteroskedasticity of residuals in large dimensions up to 1000 stocks. It displays superior all-around performance on historical data against a variety of state-of-the-art competitors, including static factor models, exogenous factor models, sparsity-based models, and structure-free dynamic models. This new estimator can be used to deliver more efficient portfolio selection and detection of anomalies in the cross-section of stock returns. |
Related URLs | |
Digital Object Identifier | 10.1093/jjfinec/nby033 |
Other Identification Number | merlin-id:18973 |
PDF File | Download from ZORA |
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Keywords | Economics and Econometrics, Finance |
Additional Information | This is a pre-copy-editing, author-produced PDF of an article accepted for publication in Journal of Financial Econometrics following peer review. The definitive publisher-authenticated version "De Nard, Gianluca; Ledoit, Olivier; Wolf, Michael (2019). Factor models for portfolio selection in large dimensions: the good, the better and the ugly. Journal of Financial Econometrics, nby033" is available online at: dx.doi.org/10.1093/jjfinec/nby033 |