Improved Covariance Matrix Estimation for Portfolio Risk Measurement: A Review

Ruili Sun, Tiefeng Ma, Shuangzhe Liu, Milind SATHYE

Research output: Contribution to journalReview article

Abstract

The literature on portfolio selection and risk measurement has considerably advanced in recent years. The aim of the present paper is to trace the development of the literature and identify areas that require further research. This paper provides a literature review of the characteristics of financial data, commonly used models of portfolio selection, and portfolio risk measurement. In the summary of the characteristics of financial data, we summarize the literature on fat tail and dependence characteristic of financial data. In the portfolio selection model part, we cover three models: mean-variance model, global minimum variance (GMV) model and factor model. In the portfolio risk measurement part, we first classify risk measurement methods into two categories: moment-based risk measurement and moment-based and quantile-based risk measurement. Moment-based risk measurement includes time-varying covariance matrix and shrinkage estimation, while moment-based and quantile-based risk measurement includes semi-variance, VaR and CVaR.
Original languageEnglish
Pages (from-to)1-33
Number of pages33
JournalJournal of Risk and Financial Management
Volume12
Issue number1
DOIs
Publication statusE-pub ahead of print - 24 Mar 2019

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Portfolio risk
Risk measurement
Covariance matrix estimation
Portfolio selection
Financial data
Quantile
Conditional value at risk
Semivariance
Shrinkage estimation
Time-varying
Mean-variance model
Selection model
Literature review
Fat tails
Minimum variance
Measurement method

Cite this

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title = "Improved Covariance Matrix Estimation for Portfolio Risk Measurement: A Review",
abstract = "The literature on portfolio selection and risk measurement has considerably advanced in recent years. The aim of the present paper is to trace the development of the literature and identify areas that require further research. This paper provides a literature review of the characteristics of financial data, commonly used models of portfolio selection, and portfolio risk measurement. In the summary of the characteristics of financial data, we summarize the literature on fat tail and dependence characteristic of financial data. In the portfolio selection model part, we cover three models: mean-variance model, global minimum variance (GMV) model and factor model. In the portfolio risk measurement part, we first classify risk measurement methods into two categories: moment-based risk measurement and moment-based and quantile-based risk measurement. Moment-based risk measurement includes time-varying covariance matrix and shrinkage estimation, while moment-based and quantile-based risk measurement includes semi-variance, VaR and CVaR.",
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Improved Covariance Matrix Estimation for Portfolio Risk Measurement: A Review. / Sun, Ruili ; Ma, Tiefeng; Liu, Shuangzhe; SATHYE, Milind.

In: Journal of Risk and Financial Management, Vol. 12, No. 1, 24.03.2019, p. 1-33.

Research output: Contribution to journalReview article

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T1 - Improved Covariance Matrix Estimation for Portfolio Risk Measurement: A Review

AU - Sun, Ruili

AU - Ma, Tiefeng

AU - Liu, Shuangzhe

AU - SATHYE, Milind

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KW - risk measure

KW - fat tail

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