Random matrix theory provides a clue to correlation dynamics

Jean-Philippe Bouchaud
07 Jan 2021

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Harry Markowitz famously quipped that diversification is the only free lunch in investing. What he did not say is that this is only true if correlations are known and stable over time.

Markowitz’s optimal portfolio offers the best risk-reward trade-off – for a given set of predictors – but requires the covariance matrix of a potentially large pool of assets to be known and representative of future realised correlations.

The empirical determination of large covariance matrices is, however

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