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Why Nobody Should Use Sample Covariance Matrices
- Fabio Capela
- Portfolio optimization , Risk management , Quantitative finance , Covariance estimation , Modern portfolio theory , Statistical methods , Asset management , Mathematical finance
Since Harry Markowitz introduced mean-variance optimization in 1952, portfolio managers have faced a persistent and frustrating problem. The mathematical elegance of Modern Portfolio Theory promises optimal asset allocation, but in practice, portfolios constructed using traditional methods often perform worse than simple equal-weight strategies. The culprit? A seemingly innocuous component that lies at the heart of every optimization: the sample covariance matrix.
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