Shrunk Empirical Correlation Matrix

Compute a linearly shrunk empirical asset correlation matrix, which is a convex combination of the empirical correlation matrix of these assets and a target correlation matrix, the target correlation matrix being either:

• An equicorrelation matrix made of 0
• An equicorrelation matrix made of the average correlation of the elements of the asset correlation matrix

References

• Olivier Ledoit, Michael Wolf, The Power of (Non-)Linear Shrinking: A Review and Guide to Covariance Matrix Estimation, Journal of Financial Econometrics, Volume 20, Issue 1, Winter 2022, Pages 187–218
• Gianluca De Nard, Oops! I Shrunk the Sample Covariance Matrix Again: Blockbuster Meets Shrinkage, Journal of Financial Econometrics, Volume 20, Issue 4, Fall 2022, Pages 569–611
• Kwan, Clarence C. Y. (2017) Shrinkage of the Sample Correlation Matrix of Returns Towards a Constant Correlation Target: A Pedagogic Illustration Based on Dow Jones Stock Returns, Spreadsheets in Education (eJSiE): Vol. 10: Iss. 1, Article 3