Testing and Support Recovery of Correlation Structures for Matrix-Valued Observations with an Application to Stock Market Data

Abstract

Estimation of the covariance matrix of asset returns is crucial to portfolio construction. As suggested by economic theories, the correlation structure among assets differs between emerging markets and developed countries. It is therefore imperative to make rigorous statistical inference on correlation matrix equality between the two groups of countries. However, if the traditional vector-valued approach is undertaken, such inference is either infeasible due to limited number of countries comparing to the relatively abundant assets, or invalid due to the violations of temporal independence assumption. This highlights the necessity of treating the observations as matrix-valued rather than vector-valued. With matrix-valued observations, our problem of interest can be formulated as statistical inference on covariance structures under sub-Gaussian distributions, i.e., testing non-correlation and correlation equality, as well as the corresponding support estimations. We develop procedures that are asymptotically optimal under some regularity conditions. Simulation results demonstrate the computational and statistical advantages of our procedures over certain existing state-of-the-art methods for both normal and non-normal distributions. Application of our procedures to stock market data reveals interesting patterns and validates several economic propositions via rigorous statistical testing.

Keywords: Kronecker product; Matrix sub-Gaussian distribution; Portfolio construction; Testing of non-correlation; One-sample and two-sample

JEL Classification: C10, G11