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Projected Dynamic Conditional Correlations

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  • Llorens-Terrazas, Jordi
  • Brownlees, Christian

Abstract

We propose a novel specification of the Dynamic Conditional Correlation (DCC) model based on an alternative normalization of the pseudo-correlation matrix called Projected DCC (Pro-DCC). Our modification consists in projecting, rather than rescaling, the pseudo-correlation matrix onto the set of correlation matrices in order to obtain a well defined conditional correlation matrix. A simulation study shows that projecting performs better than rescaling when the dimensionality of the correlation matrix is large. An empirical application to the constituents of the S&P 100 shows that the proposed methodology performs favorably to the standard DCC in an out-of-sample asset allocation exercise.

Suggested Citation

  • Llorens-Terrazas, Jordi & Brownlees, Christian, 2023. "Projected Dynamic Conditional Correlations," International Journal of Forecasting, Elsevier, vol. 39(4), pages 1761-1776.
    • Handle: RePEc:eee:intfor:v:39:y:2023:i:4:p:1761-1776
    DOI: 10.1016/j.ijforecast.2022.06.003
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    References listed on IDEAS

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