Large Volatility Matrix Prediction using Tensor Factor Structure

Sung Hoon Choi and Donggyu Kim ()
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Donggyu Kim: Department of Economics, University of California Riverside

No 202506, Working Papers from University of California at Riverside, Department of Economics

Abstract: Several approaches for predicting large volatility matrices have been developed based on high-dimensional factor-based Ito processes. These methods often impose restrictions to reduce the model complexity, such as constant eigenvectors or factor loadings over time. However, several studies indicate that eigenvector processes are also time-varying. To address this feature, this paper generalizes the factor structure by representing the integrated volatility matrix process as a cubic (order-3 tensor) form, which is decomposed into low-rank tensor and idiosyncratic tensor components. To predict conditional expected large volatility matrices, we propose the Projected Tensor Principal Orthogonal componEnt Thresholding (PT-POET) procedure and establish its asymptotic properties. The advantages of PT-POET are validated through a simulation study and demonstrated in an application to minimum variance portfolio allocation using high-frequency trading data.

Pages: 30 Pages
Date: 2025-05
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