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A new method to estimate the noise in financial correlation matrices

Guhr, Thomas LU and Kalber, Bernd (2003) In Journal of Physics A: Mathematical and General1975-01-01+01:002007-01-01+01:00 36(12). p.3009-3032
Abstract
Companies belonging to the same industrial branch are subject to similar economical influences. Hence, the time series of their stocks can show similar trends implying a correlation. Financial correlation matrices measure the unsystematic correlations between time series of stocks. Such information is important for risk management. It has been found by Laloux et al that the correlation matrices are 'noise dressed', a major reason being the finiteness of the time series. We present a new and alternative method to estimate this noise. We introduce a power mapping of the elements in the correlation matrix which suppresses the noise and thereby effectively 'prolongs' the time series. Neither further data processing nor additional input is... (More)
Companies belonging to the same industrial branch are subject to similar economical influences. Hence, the time series of their stocks can show similar trends implying a correlation. Financial correlation matrices measure the unsystematic correlations between time series of stocks. Such information is important for risk management. It has been found by Laloux et al that the correlation matrices are 'noise dressed', a major reason being the finiteness of the time series. We present a new and alternative method to estimate this noise. We introduce a power mapping of the elements in the correlation matrix which suppresses the noise and thereby effectively 'prolongs' the time series. Neither further data processing nor additional input is needed. To develop and test our method, we use a model suggested by Noh which can be viewed as a special case of a 'factor model' in economics. We perform numerical simulations for the time series and obtain correlation matrices. We support the numerics by a qualitative analytical discussion. With our approach, different correlation structures buried under this noise can be detected. Our method is general and can be applied to all systems in which time series are measured. (Less)
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author
organization
publishing date
type
Contribution to journal
publication status
published
subject
in
Journal of Physics A: Mathematical and General1975-01-01+01:002007-01-01+01:00
volume
36
issue
12
pages
3009 - 3032
publisher
IOP Publishing
external identifiers
  • wos:000182454900011
  • scopus:0242266519
ISSN
0305-4470
DOI
language
English
LU publication?
yes
id
9e8327c7-2989-4078-9df5-060ac32079a6 (old id 312688)
date added to LUP
2007-08-02 16:10:08
date last changed
2018-06-03 04:28:22
@article{9e8327c7-2989-4078-9df5-060ac32079a6,
  abstract     = {Companies belonging to the same industrial branch are subject to similar economical influences. Hence, the time series of their stocks can show similar trends implying a correlation. Financial correlation matrices measure the unsystematic correlations between time series of stocks. Such information is important for risk management. It has been found by Laloux et al that the correlation matrices are 'noise dressed', a major reason being the finiteness of the time series. We present a new and alternative method to estimate this noise. We introduce a power mapping of the elements in the correlation matrix which suppresses the noise and thereby effectively 'prolongs' the time series. Neither further data processing nor additional input is needed. To develop and test our method, we use a model suggested by Noh which can be viewed as a special case of a 'factor model' in economics. We perform numerical simulations for the time series and obtain correlation matrices. We support the numerics by a qualitative analytical discussion. With our approach, different correlation structures buried under this noise can be detected. Our method is general and can be applied to all systems in which time series are measured.},
  author       = {Guhr, Thomas and Kalber, Bernd},
  issn         = {0305-4470},
  language     = {eng},
  number       = {12},
  pages        = {3009--3032},
  publisher    = {IOP Publishing},
  series       = {Journal of Physics A: Mathematical and General1975-01-01+01:002007-01-01+01:00},
  title        = {A new method to estimate the noise in financial correlation matrices},
  url          = {http://dx.doi.org/},
  volume       = {36},
  year         = {2003},
}