Cleaning correlation matrices

Bun, Bouchaud and Potters present a technique that allow cleaning in-sample noise from correlation matrixes

Data Matrix

The concept of correlations between different assets is a cornerstone of Markowitz's optimal portfolio theory, especially for risk management purposes (Markowitz 1968). In a nutshell, correlations measure the tendency of different assets to vary together, and it is well known that large losses at a portfolio level are indeed mostly due to correlated moves of its constituents (see, for example, Bouchaud & Potters 2003). Efficient and robust diversification is needed to alleviate such events.

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