Honey , I Shrunk the Sample Covariance Matrix

@inproceedings{Equities2004HoneyI,
  title={Honey , I Shrunk the Sample Covariance Matrix},
  author={Olivier Ledoit Equities and Michael Wolf and M. Wolf},
  year={2004}
}
The central message of this paper is that nobody should be using the sample covariance matrix for the purpose of portfolio optimization. It contains estimation error of the kind most likely to perturb a mean-variance optimizer. In its place, we suggest using the matrix obtained from the sample covariance matrix through a transformation called shrinkage. This tends to pull the most extreme coefficients towards more central values, thereby systematically reducing estimation error where it matters… CONTINUE READING
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