Rank reduction of correlation matrices by majorization

R. Pietersz and Patrick Groenen ()

No EI 2004-11 Revision_Date: 2009-07-29, Econometric Institute Report from Erasmus University Rotterdam, Econometric Institute

Abstract: In this paper a novel method is developed for the problem of finding a low-rank correlation matrix nearest to a given correlation matrix. The method is based on majorization and therefore it is globally convergent. The method is computationally efficient, is straightforward to implement, and can handle arbitrary weights on the entries of the correlation matrix. A simulation study suggests that majorization compares favourably with competing approaches in terms of the quality of the solution within a fixed computational time. The problem of rank reduction of correlation matrices occurs when pricing a derivative dependent on a large number of assets, where the asset prices are modelled as correlated log-normal processes.

Keywords: rank; correlation matrix; majorization; lognormal price processes (search for similar items in EconPapers)
Date: 2004-04-01
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Working Paper: Rank Reduction of Correlation Matrices by Majorization (2005)
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Persistent link: http://EconPapers.repec.org/RePEc:dgr:eureir:1765001202

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