Hidden Noise Structure and Random Matrix Models of Stock Correlations

Details Hidden Noise Structure and Random Matrix Models of Stock Correlations Hidden Noise Structure and Random Matrix Models of Stock Correlations

2009-09-08

arxiv.org/abs/0909.1383v3

Economy

Quantitative Finance

Risk Management

4 pages, 3 figures: author initials added, references added

Scientific paper

We find a novel correlation structure in the residual noise of stock market returns that is remarkably linked to the composition and stability of the top few significant factors driving the returns, and moreover indicates that the noise band is composed of multiple subbands that do not fully mix. Our findings allow us to construct effective generalized random matrix theory market models that are closely related to correlation and eigenvector clustering. We show how to use these models in a simulation that incorporates heavy tails. Finally, we demonstrate how a subtle purely stationary risk estimation bias can arise in the conventional cleaning prescription.

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