Department of Economics and Business Economics

Anders Bredahl Kock

Estimation and Forecasting of Large Realized Covariance Matrices and Portfolio Choice

Research output: Working paperResearch


  • rp14_42

    Submitted manuscript, 1008 KB, PDF-document

    Laurent Callot, University of Amsterdam and Tinbergen Institute, Denmark
  • Anders Bredahl Kock
  • Marcelo C. Medeiros, Pontifical Catholic University of Rio de Janeiro, Brazil
In this paper we consider modeling and forecasting of large realized covariance matrices by penalized vector autoregressive models. We propose using Lasso-type estimators to reduce the dimensionality to a manageable one and provide strong theoretical performance guarantees on the forecast capability of our procedure. To be precise, we show that we can forecast future realized covariance matrices almost as precisely as if we had known the true driving dynamics of these in advance. We next investigate the sources of these driving dynamics for the realized covariance matrices of the 30 Dow Jones stocks and find that these dynamics are not stable as the data is aggregated from the daily to the weekly and monthly frequency.
The theoretical performance guarantees on our forecasts are illustrated on the Dow Jones index. In particular, we can beat our benchmark by a wide margin at the longer forecast horizons. Finally, we investigate the economic value of our forecasts in a portfolio selection exercise and find that in certain cases an investor is willing to pay a considerable amount in order get access to the forecasts.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages34
StatePublished - 17 Nov 2014
SeriesCREATES Research Papers

    Research areas

  • Realized covariance, Vector autoregression, Shrinkage, Lasso, Forecasting, Portfolio allocation

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