Questions tagged [covariance]
A measure of the degree of linear association between a pair of random variables.
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Ranking assets by covariance vs correlation
After every change in portfolio (i.e. every trade), I need to calculate a price for each asset in my portfolio. But the calculator is slow. So I want to order the sequence of price updates, from the ...
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3answers
139 views
Interpretation and units of a covariance element in portfolio risk
Given portfolio risk is $\mathbf{w}\boldsymbol{\Sigma}\mathbf{w}$ where $\boldsymbol{\Sigma}$ is the covariance matrix whose diagonal elements $\sigma^2_{n}$ are individual asset return variances and ...
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2answers
128 views
Why is portfolio optimization a convex problem if variance is concave?
Variance is concave, so portfolio risk must be too.
The mean-variance model employs quadratic programming to optimize (minimize) portfolio risk. My understanding is that quadratic programming requires ...
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26 views
Covariance of Individual Return and Portfolio Return
Hi guys,
Is it possible to get the covariance between the individual return and portfolio return given the correlation matrix, volatility matrix, weights matrix and return matrix?
I know how to get ...
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2answers
114 views
Meaning of an identity matrix for the covariance in portfolio optimization
Instead of using a sample covariance matrix for portfolio optimization, Ledoit and Wolf use an estimator that is the weighted average of the sample covariance matrix and the identity matrix, $I$. This ...
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2answers
65 views
What do large weights above 1 in a portfolio represent?
If I have a portfolio consisting of weights -12,11,3,-2,5,-5, I know that negative weights correspond to shorting but what do these large weights represent? I thought the weights are the proportion of ...
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53 views
Can I build an efficient frontier using matrix algebra?
If i have a vector of expected returns $A$, a covariance matrix $C$ and a vector of the corresponding weights $W$ for each investment, is it possible to generate the efficient frontier with vector ...
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3answers
171 views
Simulating covariance matrices with nonzero correlation
How would you simulate a covariance matrix of 1,000 stocks where each pair has nonzero correlation?
I have literally no idea how to start with this.
Any suggestions?
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1answer
85 views
Variance-Covariance Matrix under $\mathbb{P}$ and $\mathbb{Q}$
I'd like to understand why $\Sigma$ is the same under both measures $\mathbb{P}$ and $\mathbb{Q}$.
Is it an assumption or a general fact based on theoretical concepts?
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1answer
50 views
Covariation of Ito semimartingales
If we have two Ito semimartingales over $[0,T]$:
$$d X_t^i=a^i_tdt+\sigma_t^idW_t^i,\quad i=1,2$$
What is the relationship between
$$\langle X^1,X^2 \rangle_t \quad \text{and} \quad \langle W^1,W^2 \...
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23 views
Decomposition of Contribution to Variance
$C$ is a $N\times N$ covariance matrix of stock returns. Assuming $w$ is a vector of positions in each asset, the total variance of the portfolio is
$$w^TCw$$
The contribution to total variance of the ...
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1answer
64 views
How do i find the covariance between two portfolios?
I know that the formula for covariance is
But this is for two securities. How do I find the covariance between two portfolios? more specifically between the global minimum variance (GMV) and the mean-...
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1answer
94 views
Turning a covariance sum into an integral
I am reading Lorenzo's Bergomi's book Stochastic Volatility Modeling, and I have come to this passage.
I just would like to understand the derivation between the first and the second equality. I ...
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52 views
covariance matrix in the CAPM model
I'm running a simulation for a 5 asset portfolio, calculating the optimal weights of each asset both with the statistical model (i.e. single index) and with the CAPM. my question is: how do you ...
0
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1answer
106 views
Computing covariance matrix with historical data
I have been reading Active Portfolio Management by Grinold and Khan. In the chapter about risk, they mention,
"The third elementary model relies on historical variances and covariances. This ...
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1answer
38 views
Decomposing Co-variance of Two Assets Terminal Prices into Forward measures
Let $X_T,Y_T$ be the terminal values of two price processes following Continuous Gaussian Motion (I.E.) let us assume no jumps. Further assume the correct forwards/futures price is given by $F^X_{t,T} ...
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56 views
Trading Bands for Tactical Asset Allocation
I am currently working through Portfolio Construction and Risk Budgeting, 4th edition, by Dr. Bernd Scherer.
In chapter 12.6 the following methodology to construct trading bands around a tactical ...
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1answer
69 views
Calculating covariance from three variances
I have been asked to look to refactor some code.
There is a line shown below:
$\text{implied covariance} = -\frac{(\text{var}_1 - \text{var}_2 - \text{var}_3)} {2}$,
where $\text{var}_1$ is the ...
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31 views
Is there a differentiable formulation of Prado's HRP algo?
I get the sense the algo is just a graph representation the dependency structure. Am wondering if there is anything written on learning the weights by optimizing some parameters rather than a forward ...
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2answers
150 views
Estimate covariance matrix using prices
We generally estimate the covariance matrix of assets using their returns instead of prices. Why is that the case?
I can think of two possible reasons and would appreciate comments/feedback regarding ...
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0answers
37 views
Mean-Variance Optimization - Appropriate to use covariance of daily returns if strategy involves fixed hold of 3 months?
I'm implementing the strategy outlined Quantitative Momentum (Gray & Vogel), which basically involves investing each quarter in a set of "high-quality momentum stocks" for a fixed 3-month hold ...
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6answers
260 views
Is a more robust Covariance estimation possible?
I'm working on a mean-variance optimization problem, but instead of financial securities I'm choosing a 'portfolio' of N athletes. It is a 1-period optimization problem over one generic statistic ...
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1answer
149 views
Covariance - Negative Portfolio
How do you calculate the one day standard deviation (in dollars) for a portfolio that is short $30,000? How do you calculate the weightings to use? I already have the necessary covariance matrix.
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53 views
One day standard deviation of a portfolio (long/short, different scalars)
I am attempting to calculate the expected one-day standard deviation of a portfolio in dollars. In other words, I am looking for the following: "I expect my portfolio to move _______ dollars on ...
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1answer
199 views
Questions about beta, correlation, and covariance
Currently, I calculate beta, correlation, and covariance measures using daily log normal returns of Security A and Benchmark A. What would it mean if I were to use daily log normal excess returns in ...
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39 views
Covariance time frequency
I have rolling 3-year returns for an asset and a benchmark.
I want to compare the covariance of the asset and benchmark, should I use the covariance of the rolling 3-year returns or the covariance ...
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1answer
71 views
Covariance matrix from GJR-GARCH?
I am implementing a AR(1)-GJR-GARCH(1,1) model to some asset returns, and I would need to have a covariance matrix but I struggle to see how I can compute one from the model I used?
I know I can have ...
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1answer
193 views
Why the weight vector of 'global minimum variance' the 'eigenvector' with the minimum eigenvalue?
Question
Why is it the case that the weight vector of the global minimum variance portfolio the eigenvector of the covariance matrix with the smallest eigenvalue?
Question with more details
I ...
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2answers
497 views
Widely accepted methods for coming up with the co-variance matrix of assets?
Question
What are the widely accepted ways for coming up with co-variance matrix of assets
after the Markowitz's modern portfolio theory?
Question explained in more detail
After Modern portfolio ...
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1answer
60 views
Generate scenarios of multiple related parameters
Assume I have three industry datasets: interest rates, inflation and unemployment. Data contains information of last ten years and it's monthly.
Now, I would like to create N possible scenarios of ...
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0answers
94 views
Why are thousand-ish-factor vendor risk models not extremely overfit and inaccurate?
Many vendor risk models have many hundreds, or even thousands of factors (many of which are highly correlated with each other). Underlying all these risk models is some sort of covariance matrix in ...
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2answers
159 views
Prove Ļ(X,Z) = Ļ
The covariance of two random variables $X$ and $Y$ is defined by:
$$\mathrm{Cov}(X,Yļ¼= \operatorname{E}(X-\operatorname{E}(X))(Y-\operatorname{E}(Y))=\operatorname{E}(XY)-\operatorname{E}(X)\...
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1answer
97 views
Co-variance of Portfolio A with Portfolio B
I'm trying to calculate the correlation between two separate portfolios.
I've used A*COV(AB)*B to calculate the co-variance of each portfolio where:
A = Array ...
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0answers
108 views
Is Ledoit-Wolf Shrinkage with a Constant Correlation Prior Reasonable for a Stock/Bond Mix?
I've been looking into Ledoit-Wolf shrinkage but I've found the papers concentrate on large numbers of assets that tend to all be highly correlated. Often a universe of large cap stocks.
I'm ...
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1answer
97 views
Covariance and Beta: can anyone explain this calculation?
Let us consider a simple equity portfolio that has exposures to only two factors:
0.5 exposure to value and 0.8 exposure to momentum. Let us assume that the volatilities of the two factors are 3% for ...
2
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1answer
406 views
How to calculate the covariance between two stochastic integrals?
How to calculate the covariance between the integral of a Brownian motion at different times:
$$\text{Cov}\left(\int^{t_1}_0\sigma(t)dW_t,\int^{t_2}_0\sigma(t)dW_t\right)\ ?$$
I know the answer is:
$$\...
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1answer
268 views
target market correlation for long / short equity portfolio
Given a long / short equity portfolio, I want to have some net long market exposure.
My portfolio volatility is fixed to a target, so I don't think it makes sense to target market beta. I think I ...
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1answer
101 views
What are the units of the variance of returns?
I am a little confused about the units of the variance of returns. One way to compute that would be to look at the units of returns-
$$r=\frac{1}{\Delta t}\ln\frac{P(t+\Delta t)}{P(t)}=\text{...
3
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2answers
430 views
Filtering smallest eigenvalues
In Risk Budgeting and Diversification Based on Optimized Uncorrelated Factors [1], which introduces minimum torsion bets, Meucci gives an example involving the computation of covariance matrices on ...
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3answers
1k views
Negative variance?
Using the formula w*Cov*t(w) I can generate a negative portfolio variance. What are the implications of a negative variance? Should I just assume it's zero? A negative variance is troublesome ...
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1answer
208 views
Variance covariance matrix - number of periods required
Hi I am reviewing the example of Barra risk model in the following document page 23 there is the statement:
"Estimating a covariance matrix for, say, 3,000 stocks requires data
for at least 3,...
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3answers
2k views
CAPM model as a regression
The CAPM model states that the returns of a stock are-
$r_s=r_f+\beta (r_m-r_f)+\varepsilon_s$
The $\beta$ defined above is then calculated as $\frac{cov(r_s,r_m)}{var(r_m)}$. My question is ...
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1answer
147 views
Finding a minimum variance portfolio when using a regulariser?
I am aware that the minimum variance portfolio of a market with $n$ securities can be shown to be:
\begin{equation}
w^* = (1^T_n\Sigma^{-1}1_n)^{-1}\Sigma^{-1}1_n, \\ s.t. \ \ 1^T_nw = 1
\end{...
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1answer
30 views
Factor Models: uncorrelated errors don't impact covariances of assets
This question stems from time series factor models (e.g., CAPM, Fama-French, etc.), but is a broader idea.
I am trying to comprehend how adding noise to a time series (e.g., error/residual from a ...
3
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0answers
209 views
Parametric VaR of a portfolio of a stock and an option on that stock
I understand how to calculate the parametric VaR of a stock and an option separately. But I don't understand how one can calculate the VaR of a portfolio of a stock and an option on that stock using ...
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1answer
130 views
Interest rate risk using copulas
In order to simulate an interest rate yield curve, can I just estimate a covariance matrix of historical key rate data, simulate with a normal copula, spline my simulated key rates, then price my ...
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1answer
456 views
Correlation of asset X with a portfolio of asset Y and Z [closed]
I have three assets and a covariance matrix.
How do I calculate the correlation of asset X with a portfolio that includes assets Y and Z?
For example, assume I want to calculate the correlation of ...
6
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1answer
347 views
How can I use a more efficient volatility estimator to improve the co-variance matrix?
Using mean-variance, I need to estimate a co-variance matrix $\Sigma$ to obtain the best weights in my portfolio.
However, there are other ways to compute the volatility $\sigma$ than historical ...
1
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2answers
122 views
Explanations regarding Minimum Variance Portfolio
I am sorry in advance if this question seems a bit stupid but during my class my lecturer said that:
"The traditional estimator of the variance-covariance matrix is the sample covariance. However ...
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0answers
90 views
Deriving Cox, Ingersoll and Ross expression for the relationship between forwards and futures, how do they conclude a specific step?
I'm trying to derive a specific relationship about the relationship between forwards and futures from "The relationship between forward and futures prices", written 1981 by Cox, Ingersoll and Ross (...
