Estimation risk in covariance

David D Cho
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David D Cho: Huizenga School of Business, Nova Southeastern University

Journal of Asset Management, 2011, vol. 12, issue 4, No 3, 248-259

Abstract: Abstract This article investigates the estimation risk in covariance. Although previous research has shown that the covariance can be estimated accurately by assuming independently and identically distributed normal returns, time-varying volatility and non-normality can lead to imprecise covariance estimates, which can cause economic loss to a mean variance investor. Applying the Fama-French three-factor model to 25 portfolios sorted by size and book-to-market ratio from 1963 to 2008, we find that the estimation risk in covariance is as large as two-thirds of that in the expected return.

Keywords: estimation risk; portfolio choice; time-varying volatility; Bayesian analysis (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (3)

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DOI: 10.1057/jam.2011.14

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