In an asset management industry, calculating the return and risk of a portfolio is common type of task. When we want to calculate the risk of the portfolio, we have to find the variance-covariance matrix. However, the sample variance-covariance matrix contains estimation error when the number of stocks under consideration is large, especially relative to the number of historical return observations available (which is the usual case). To solve this problem, we can minimize the error by using a transformation called shrinkage.
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