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Beta-Adjusted Covariance Estimation

Author

Listed:
  • Kirill Dragun
  • Kris Boudt
  • Orimar Sauri
  • Steven Vanduffel

Abstract

The increase in trading frequency of Exchanged Traded Funds (ETFs) presents a positive externality for nancial risk management when the price of the ETF is available at a higher frequency than the price of the component stocks. The positive spillover consists in improving the accuracy of pre-estimators of the integrated covariance of the stocks included in the ETF. The proposed Beta Adjusted Covariance (BAC) equals the preestimator plus a minimal adjustment matrix such that the covariance-implied stock-ETF beta equals a target beta. We focus on the Hayashi and Yoshida (2005) pre-estimator and derive the asymptotic distribution of its implied stock-ETF beta. The simulation study conrms that the accuracy gains are substantial in all cases considered. In the empirical part of the paper, we show the gains in tracking error eciency when using the BAC adjustment for constructing portfolios that replicate a broad index using a subset of stocks.

Suggested Citation

  • Kirill Dragun & Kris Boudt & Orimar Sauri & Steven Vanduffel, 2021. "Beta-Adjusted Covariance Estimation," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 21/1010, Ghent University, Faculty of Economics and Business Administration.
    • Handle: RePEc:rug:rugwps:21/1010
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    References listed on IDEAS

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    More about this item

    Keywords

    High-frequency data; realized covariances; ETF; asynchronicity; stock-ETF beta; Localized Hayashi-Yoshida; Index tracking;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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