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Finding a Valid FX Covariance Matrix in the BS World

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  • Maxim Bouev

Abstract

A number of methods has already been proposed for creating a valid correlation matrix in finance. However, such methods do not normally take into account additional restrictions on matrix elements imposed by specific non-arbitrage conditions in some markets, e.g. foreign exchange (FX). I suggest that taking those restrictions, known as triangular relationships, into account can lead to a more efficient method of correction of invalid correlation matrices, at least in FX markets. This paper outlines the steps of the new method.

Suggested Citation

  • Maxim Bouev, 2012. "Finding a Valid FX Covariance Matrix in the BS World," EUSP Department of Economics Working Paper Series Ec-03/12, European University at St. Petersburg, Department of Economics.
  • Handle: RePEc:eus:wpaper:ec0312
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    More about this item

    Keywords

    correlation matrix; eigenvalue; foreign exchange; triangular relationship; quantitative finance;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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