Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/248767 
Year of Publication: 
2021
Series/Report no.: 
Tinbergen Institute Discussion Paper No. TI 2021-083/IV
Publisher: 
Tinbergen Institute, Amsterdam and Rotterdam
Abstract: 
The Dynamic Conditional Correlation (DCC) model by Engle (2002) has become an extremely popular tool for modeling the time-varying dependence of asset returns. However, applications to large cross-sections have been found to be problematic, due to the curse of dimensionality. We propose a novel DCC model with Conditional LInear Pooling (CLIP-DCC) which endogenously determines an optimal degree of commonality in the correlation innovations, allowing a part of the update to be of reduced dimension. In contrast to existing approaches such as the Dynamic EquiCOrrelation (DECO) model, the CLIP-DCC model does not restrict long-run behavior, thereby naturally complementing target correlation matrix shrinkage approaches. Empirical findings suggest substantial benefits for a minimum-variance investor in real-time. Combining the CLIP-DCC model with target shrinkage yields the largest improvements, confirming that they address distinct parts of uncertainty of the conditional correlation matrix.
Document Type: 
Working Paper

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