) CORTEZ’S STATEMENT TO USE THE WORK OF BOTH FIRMS TO DETERMINE A COVARIANCE ESTIMATE IS MOST LIKELY AN EXAMPLE OF
4.) Cortez’s statement to use the work of both firms to determine a covariance estimate is
most likely an example of:
A.
a prudence trap.
B.
a shrinkage estimate.
C.
nonstationarity.
Answer =B
Cortez’s statement to calculate a weighted average for the covariance estimate is an
example of shrinkage estimation. Shrinkage estimation involves taking a weighted
average of a historical estimate of a parameter and some other parameter estimate, in
which the weights reflect the analyst’s relative belief in the estimates. A shrinkage
estimator of the covariance matrix is a weighted average of the historical covariance
matrix and an alternative estimator of the covariance matrix.
“Capital Market Expectations,” by John P. Calverley, Alan M. Meder, Brian D. Singer,
and Renato Staub
Sections 2.2.3, 2.2.8, 3.1.1.2