Predicting the Daily Covariance Matrix for S&P 100 Stocks Using Intraday Data - But Which Frequency to Use?

Tinbergen Institute Discussion Paper No. 05-089/4

29 Pages Posted: 2 Nov 2005

See all articles by Michiel De Pooter

Michiel De Pooter

Board of Governors of the Federal Reserve System

Martin Martens

Erasmus University Rotterdam (EUR); Robeco Asset Management

Dick J. C. van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM

Date Written: September 21, 2005

Abstract

This paper investigates the merits of high-frequency intraday data when forming minimum variance portfolios and minimum tracking error portfolios with daily rebalancing from the individual constituents of the S&P 100 index. We focus on the issue of determining the optimal sampling frequency, which strikes a balance between variance and bias in covariance matrix estimates due to market microstructure effects such as non-synchronous trading and bid-ask bounce. The optimal sampling frequency typically ranges between 30- and 65-minutes, considerably lower than the popular five-minute frequency. We also examine how bias-correction procedures, based on the addition of leads and lags and on scaling, and a variance-reduction technique, based on subsampling, affect the performance.

Keywords: realized volatility, high-frequency data, volatility timing, mean-variance analysis, tracking error

JEL Classification: G11

Suggested Citation

De Pooter, Michiel and Martens, Martin P.E. and van Dijk, Dick J.C., Predicting the Daily Covariance Matrix for S&P 100 Stocks Using Intraday Data - But Which Frequency to Use? (September 21, 2005). Tinbergen Institute Discussion Paper No. 05-089/4. Available at SSRN: https://ssrn.com/abstract=829545 or http://dx.doi.org/10.2139/ssrn.829545

Michiel De Pooter

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Martin P.E. Martens

Erasmus University Rotterdam (EUR) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 1253 (Phone)
+31 10 408 9162 (Fax)

Robeco Asset Management ( email )

Rotterdam, 3011 AG
Netherlands

Dick J.C. Van Dijk (Contact Author)

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute

P.O. Box 1738
3000 DR Rotterdam
Netherlands

ERIM ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 1263 (Phone)
+31 10 4089162 (Fax)

HOME PAGE: http://people.few.eur.nl/djvandijk

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