• Media type: Report; E-Book
  • Title: Nonlinear shrinkage of the covariance matrix for portfolio selection: Markowitz meets Goldilocks
  • Contributor: Ledoit, Olivier [Author]; Wolf, Michael [Author]
  • Published: Zurich: University of Zurich, Department of Economics, 2014
  • Language: English
  • DOI: https://doi.org/10.5167/uzh-90273
  • Keywords: Markowitz portfolio selection ; nonlinear shrinkage ; G11 ; C13 ; Large-dimensional asymptotics
  • Origination:
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  • Description: Markowitz (1952) portfolio selection requires estimates of (i) the vector of expected returns and (ii) the covariance matrix of returns. Many proposals to address the first question exist already. This paper addresses the second question. We promote a new nonlinear shrinkage estimator of the covariance matrix that is more flexible than previous linear shrinkage estimators and has 'just the right number' of free parameters (that is, the Goldilocks principle). In a stylized setting, the nonlinear shrinkage estimator is asymptotically optimal for portfolio selection. In addition to theoretical analysis, we establish superior real-life performance of our new estimator using backtest exercises.
  • Access State: Open Access