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Exponential smoothing weighted correlations

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Listed:
  • F. Pozzi
  • T. Matteo
  • T. Aste

Abstract

In many practical applications, correlation matrices might be affected by the “curse of dimensionality” and by an excessive sensitiveness to outliers and remote observations. These shortcomings can cause problems of statistical robustness especially accentuated when a system of dynamic correlations over a running window is concerned. These drawbacks can be partially mitigated by assigning a structure of weights to observational events. In this paper, we discuss Pearson’s ρ and Kendall’s τ correlation matrices, weighted with an exponential smoothing, computed on moving windows using a data-set of daily returns for 300 NYSE highly capitalized companies in the period between 2001 and 2003. Criteria for jointly determining optimal weights together with the optimal length of the running window are proposed. We find that the exponential smoothing can provide more robust and reliable dynamic measures and we discuss that a careful choice of the parameters can reduce the autocorrelation of dynamic correlations whilst keeping significance and robustness of the measure. Weighted correlations are found to be smoother and recovering faster from market turbulence than their unweighted counterparts, helping also to discriminate more effectively genuine from spurious correlations. Copyright EDP Sciences, SIF, Springer-Verlag Berlin Heidelberg 2012

Suggested Citation

  • F. Pozzi & T. Matteo & T. Aste, 2012. "Exponential smoothing weighted correlations," The European Physical Journal B: Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 85(6), pages 1-21, June.
    • Handle: RePEc:spr:eurphb:v:85:y:2012:i:6:p:1-21:10.1140/epjb/e2012-20697-x
    DOI: 10.1140/epjb/e2012-20697-x
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    References listed on IDEAS

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    1. J. P. Bouchaud & M. Potters, 2009. "Financial Applications of Random Matrix Theory: a short review," Papers 0910.1205, arXiv.org.
    2. Young-Hye Cho & Robert F. Engle, 1999. "Time-Varying Betas and Asymmetric Effect of News: Empirical Analysis of Blue Chip Stocks," NBER Working Papers 7330, National Bureau of Economic Research, Inc.
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    Statistical and Nonlinear Physics;

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