Journal
JOURNAL OF ECONOMETRICS
Volume 210, Issue 1, Pages 98-115Publisher
ELSEVIER SCIENCE SA
DOI: 10.1016/j.jeconom.2018.11.007
Keywords
Dynamic correlation; Factor stochastic volatility; Curse of dimensionality; Shrinkage; Minimum variance portfolio
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We address the curse of dimensionality in dynamic covariance estimation by modeling the underlying co-volatility dynamics of a time series vector through latent time-varying stochastic factors. The use of a global-local shrinkage prior for the elements of the factor loadings matrix pulls loadings on superfluous factors towards zero. To demonstrate the merits of the proposed framework, the model is applied to simulated data as well as to daily log-returns of 300 S&P 500 members. Our approach yields precise correlation estimates, strong implied minimum variance portfolio performance and superior forecasting accuracy in terms of log predictive scores when compared to typical benchmarks. (C) 2018 The Author(s). Published by Elsevier B.V.
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