Robust Detection of Multivariate Outliers in Asset Returns and Risk Factors Data

35 Pages Posted: 2 Oct 2017

Date Written: September 30, 2017

Abstract

It is well-known that outliers exist in the type of multivariate data used by financial practitioners for portfolio construction and risk management. Typically, outliers are addressed prior to model fitting by applying some combination of trimming and/or Winsorization to each individual variable. This approach often fails to detect and/or mitigate multivariate outliers. Existing literature documents the use of the robust Mahalanobis squared distance (RSD) based on the minimum covariance determinant (MCD) estimator to detect and to shrink multivariate outliers in financial data. We use MCD-based RSDs, along with a modified version of the Iterated Reweighted MCD methodology of Cerioli, to illustrate the presence of outliers in the asset returns and firm fundamental data that equity portfolio managers would use to build and monitor portfolios. We demonstrate how RSDs based on the MCD estimate are superior to Mahalanobis distances based on the classical mean and covariance estimates for detecting multivariate outliers. In the process, we show that univariate trimming and Winsorization are insufficient to deal with multivariate outliers in financial data.

Keywords: outlier detection, Mahalanobis distances, robust statistics, factor models, Winsorization

JEL Classification: C10, C13, C18, C21

Suggested Citation

Green, Christopher G and Martin, R. Douglas, Robust Detection of Multivariate Outliers in Asset Returns and Risk Factors Data (September 30, 2017). Available at SSRN: https://ssrn.com/abstract=3046092 or http://dx.doi.org/10.2139/ssrn.3046092

R. Douglas Martin

University of Washington ( email )

Applied Mathematics & Statistics
Seattle, WA 98195
United States

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