Linear Shrinkage Estimation of Large Covariance Matrices with Use of Factor Models

Yuki Ikeda and Tatsuya Kubokawa
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Yuki Ikeda: Graduate School of Economics, The University of Tokyo
Tatsuya Kubokawa: Faculty of Economics, The University of Tokyo

No CIRJE-F-958, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

Abstract: The problem of estimating large covariance matrices with use of factor models is addressed when both the sample size and the dimension of covariance matrix tend to innity. In this paper, we consider a general class of weighted estimators which includes (i) linear combinations of the sample covariance matrix and the model-based estimator under the factor model and (ii) ridge-type estimators without factors as special cases. The optimal weights in the class are derived, and the plug-in weighted estimators are suggested since the optimal weights depend on unknown parameters. Numerical results show our methods perform well. Finally, an application to portfolio managements is given. --

Pages: 31 pages
Date: 2015-02
New Economics Papers: this item is included in nep-ecm
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Persistent link: https://EconPapers.repec.org/RePEc:tky:fseres:2015cf958

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