Beta-Adjusted Covariance Estimation

The increase in trading frequency of Exchanged Traded Funds (ETFs) presents a positive externality for financial risk management when the price ETF is available at higher than component stocks. spillover consists improving accuracy pre-estimators integrated covariance stocks included ETF. proposed Beta Adjusted Covariance (BAC) equals pre-estimator plus minimal adjustment matrix such that covariance-implied stock-ETF beta target beta. We focus on Hayashi and Yoshida (2005) derive asymptotic distribution its implied simulation study confirms gains are substantial all cases considered. In empirical part paper, we show tracking error efficiency using BAC constructing portfolios replicate broad index subset