Dynamic Principal Component CAW Models for High-Dimensional Realized Covariance Matrices

Abstract

We propose a new dynamic principal component CAW model (DPC-CAW) for time-series of high-dimensional realized covariance matrices of asset returns. The model performs a spectral decomposition of the scale matrix of a central Wishart distribution and assumes independent dynamics for the principal components' variances and the eigenvector processes. A three-step estimation procedure makes the model applicable to high-dimensional covariance matrices. We analyze the finite sample properties of the estimation approach and provide an empirical application to realized covariance matrices for 100 assets. The DPC-CAW model has particularly good forecasting properties and outperforms its competitors for realized covariance matrices.