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International Finance Discussion Papers
The International Finance Discussion Papers logo links to the International Finance Discussion Papers home page On the Inverse of the Covariance Matrix in Portfolio Analysis
Guy V.G. Stevens

Abstract:  The goal of this study is the derivation and application of a direct characterization of the inverse of the covariance matrix central to portfolio analysis. As argued below, such a specification, in terms of a few primitive constructs, provides new and illuminating expressions for such key concepts as the optimal holdings of a given risky asset and the slope of the risk-return efficiency locus faced by the individual investor. The building blocks of the inverse turn out to be the regression coefficients and residual variance optained by regressing the asset's excess return on the set of excess returns for all other risky assets.

Full paper (155 KB PDF) | Full paper (1159 KB Postscript)

Risk, uncertainty, optimal hedge

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