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A novel robust method for estimating the covariance matrix of financial returns with applications to risk management

Author

Listed:
  • Arturo Leccadito

    (University of Calabria
    LFIN/LIDAM, UCLouvain)

  • Alessandro Staino

    (University of Calabria)

  • Pietro Toscano

    (Fidelity Investments)

Abstract

This study introduces the dynamic Gerber model (DGC) and evaluates its performance in the prediction of Value at Risk (VaR) and Expected Shortfall (ES) compared to alternative parametric, non-parametric and semi-parametric methods for estimating the covariance matrix of returns. Based on ES backtests, the DGC method produces, overall, accurate ES forecasts. Furthermore, we use the Model Confidence Set procedure to identify the superior set of models (SSM). For all the portfolios and VaR/ES confidence levels we consider, the DGC is found to belong to the SSM.

Suggested Citation

  • Arturo Leccadito & Alessandro Staino & Pietro Toscano, 2024. "A novel robust method for estimating the covariance matrix of financial returns with applications to risk management," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 10(1), pages 1-28, December.
    • Handle: RePEc:spr:fininn:v:10:y:2024:i:1:d:10.1186_s40854-024-00642-2
    DOI: 10.1186/s40854-024-00642-2
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