ETF Basket-Adjusted Covariance estimation

Kris Boudt, Kirill Dragun, Orimar Sauri, Steven Vanduffel

Research output: Contribution to journalArticlepeer-review

31 Downloads (Pure)

Abstract

The increase in trading frequency of Exchanged Traded Funds (ETFs) presents a positive externality for financial risk management when the price of the ETF is available at a higher frequency than the price of the component stocks. The positive spillover consists in improving the accuracy of pre-estimators of the integrated covariance of the stocks included in the ETF basket. The proposed ETF Basket-Adjusted Covariance (BAC) equals the pre-estimator plus a minimal adjustment matrix such that the covariance-implied stock-ETF covariation equals a target value. We focus on a truncated pre-averaged version of the (Hayashi and Yoshida, 2005) pre-estimator and derive the asymptotic properties of its implied stock-ETF covariation. The simulation study confirms that the accuracy gains are substantial in all cases considered. In the empirical part of the paper, we show the gains in tracking error efficiency when using the BAC adjustment to construct portfolios that replicate a broad index using a subset of stocks.
Original languageEnglish
Pages (from-to)1144-1171
Number of pages28
JournalJournal of Econometrics
Volume235
Issue number2
DOIs
Publication statusPublished - Aug 2023

Bibliographical note

Funding Information:
This research has benefited from the financial support of the Flemish Science Foundation (FWO), Belgium . We are grateful to the editor, the associate editor, two anonymous reviewers, Dries Cornilly, Olivier Scaillet, Emil Sjoerup, and Tim Verdonck for their constructive comments. We also thank participants at various conferences and seminars for helpful comments.

Publisher Copyright:
© 2022 The Author(s)

Copyright:
Copyright 2023 Elsevier B.V., All rights reserved.

Fingerprint

Dive into the research topics of 'ETF Basket-Adjusted Covariance estimation'. Together they form a unique fingerprint.

Cite this