# Ledoit Wolf shrinkage with constant correlation prior with tawny and Riskporfolios

I am trying to use R to perform the shrinkage of covariance matrix towards constant correlation as defined in 'Honey, I Shrunk the Sample Covariance Matrix'.

I see there are two packages where this is already implemented:

library(MASS)
library(tawny)
library(RiskPortfolios)
set.seed(10)

matrixA=mvrnorm(n = 10000, 0.5, 0.2, tol = 1e-6, empirical = TRUE, EISPACK = FALSE)
matrixA=matrix(matrixA,500,20)

• tawny:

cov_shrink(matrixA)

• Risk Porfolios:

covEstimation(matrixA,control=list(type="cor"))

The output should be the same covariance matrix however this doesn't happen. Would anyone know why?

• cov_shrink lets you supply multiple possible shrinkage targets: are you using the constant correlation target for both? Jun 3, 2018 at 11:57
• I believe from some resources that the default of the function cov_shrink is the LW shrinkage to CC, for instance check: systematicinvestor.wordpress.com/2011/11/11/…. However I have tried also with 'cov_shrink(matrixA,prior.fun=cov.prior.cc)' or 'F <- cov.prior.cc(S) cov_shrink(matrixA,prior.fun=F)' but it is not working. Jun 3, 2018 at 13:59
• Interesting... may I ask how different they are? Perhaps you could edit the question to include a small sample of the output? I suggest you start by making sure that both packages are using the same covariance model: if nobody answers by tomorrow I’ll dig a bit deeper into the R source code to have a look. Jun 3, 2018 at 14:49

You can try to run the first line of code for a smaller matrix:

matrixA=mvrnorm(n = 20, 0.5, 0.2, tol = 1e-6, empirical = TRUE, EISPACK = FALSE)
matrixA=matrix(matrixA,5,4)


and the by using:

cov.shrink(matrixA):

> [1,] 0.2642444 0.0000000 0.0000000 0.0000000
[2,] 0.0000000 0.2064425 0.0000000 0.000000
[3,] 0.0000000 0.0000000 0.2318104 0.0000000
[4,] 0.0000000 0.0000000 0.0000000 0.1624061


whereas with covEstimation(matrixA,control=list(type="cor")): I get:

            [,1]        [,2]        [,3]        [,4]
[1,]  0.27315366 -0.04648824 -0.05445814 -0.02765077
[2,] -0.04648824  0.14779198 -0.04005758 -0.02033898
[3,] -0.05445814 -0.04005758  0.20281035 -0.02382587
[4,] -0.02765077 -0.02033898 -0.02382587  0.05228524


I believe there is some issue with Tawny or it is not clear what is the outcome, also based on the comment in https://systematicinvestor.wordpress.com/2011/11/11/resampling-and-shrinkage-solutions-to-instability-of-mean-variance-efficient-portfolios/

• In general there's no reason why all of the non-diagonal elements of the shrunk matrix should be zero... very weird. Jun 7, 2018 at 10:33