A New Method to Estimate the Noise in Financial Correlation Matrices

Details A New Method to Estimate the Noise in Financial Correlation Matrices A New Method to Estimate the Noise in Financial Correlation Matrices

2002-06-28

arxiv.org/abs/cond-mat/0206577v1

Physics

Condensed Matter

Statistical Mechanics

25 pages, 8 figures

Scientific paper

10.1088/0305-4470/36/12/310

Financial correlation matrices measure the unsystematic correlations between stocks. Such information is important for risk management. The correlation matrices are known to be ``noise dressed''. We develop a new and alternative method to estimate this noise. To this end, we simulate certain time series and random matrices which can model financial correlations. With our approach, different correlation structures buried under this noise can be detected. Moreover, we introduce a measure for the relation between noise and correlations. Our method is based on a power mapping which efficiently suppresses the noise. Neither further data processing nor additional input is needed.

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