Finding a Valid FX Covariance Matrix in the BS World
No 2012/03, EUSP Department of Economics Working Paper Series from European University at St. Petersburg, Department of Economics
A number of methods has already been proposed for creating a valid correlation matrix in finance. However, such methods do not normally take into account additional restrictions on matrix elements imposed by specific non-arbitrage conditions in some markets, e.g. foreign exchange (FX). I suggest that taking those restrictions, known as triangular relationships, into account can lead to a more efficient method of correction of invalid correlation matrices, at least in FX markets. This paper outlines the steps of the new method.
Keywords: correlation matrix; eigenvalue; foreign exchange; triangular relationship; quantitative finance (search for similar items in EconPapers)
JEL-codes: C63 (search for similar items in EconPapers)
Pages: 28 pages
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