In probability theory and statistics, a covariance matrix (also known as dispersion matrix or variance–covariance matrix) is a matrix whose element in the i, j position is the covariance between the i th and j th elements of a random vector (that is, of a vector of random variables). Each element of the vector is a scalar random variable, either with a finite number of observed empirical values or with a finite or infinite number of potential values specified by a theoretical joint probability distribution of all the random variables.
Intuitively, the covariance matrix generalizes the notion of variance to multiple dimensions. As an example, the variation in a collection of random points in two-dimensional space cannot be characterized fully by a single number, nor would the variances in the x and y directions contain all of the necessary information; a 2×2 matrix would be necessary to fully characterize the two-dimensional variation.
- 1 Definition
- 2 Conflicting nomenclatures and notations
- 3 Properties
- 4 As a linear operator
- 5 Which matrices are covariance matrices?
- 6 How to find a valid correlation matrix
- 7 Complex random vectors
- 8 Estimation
- 9 As a parameter of a distribution
- 10 Applications
- 11 See also
- 12 References
- 13 Further reading
Throughout this article, boldfaced unsubscripted X and Y are used to refer to random vectors, and unboldfaced subscripted Xi and Yi are used to refer to random scalars.
If the entries in the column vector
is the expected value of the ith entry in the vector X. In other words, we have
The inverse of this matrix, is the inverse covariance matrix, also known as the concentration matrix or precision matrix; see precision (statistics). The elements of the precision matrix have an interpretation in terms of partial correlations and partial variances.
Generalization of the variance
The definition above is equivalent to the matrix equality
This form can be seen as a generalization of the scalar-valued variance to higher dimensions. Recall that for a scalar-valued random variable X
Indeed, the entries on the diagonal of the covariance matrix are the variances of each element of the vector .
A quantity closely related to the covariance matrix is the correlation matrix, the matrix of Pearson product-moment correlation coefficients between each of the random variables in the random vector , which can be written
where is the matrix of diagonal elements of (i.e. a diagonal matrix of each of the variances of Xi).
Equivalently, the correlation matrix can be seen as the covariance matrix of the standardized random variables Xi / σ (Xi) for i = 1, ..., n.
Conflicting nomenclatures and notations
Nomenclatures differ. Some statisticians, following the probabilist William Feller, call the matrix the variance of the random vector , because it is the natural generalization to higher dimensions of the 1-dimensional variance. Others call it the covariance matrix, because it is the matrix of covariances between the scalar components of the vector . Thus
However, the notation for the cross-covariance between two vectors is standard:
The var notation is found in William Feller's two-volume book An Introduction to Probability Theory and Its Applications, but both forms are quite standard and there is no ambiguity between them.
The matrix is also often called the variance-covariance matrix since the diagonal terms are in fact variances.
For and , where X is a random p-dimensional variable and Y a random q-dimensional variable, the following basic properties apply:
where and are random p×1 vectors, is a random q×1 vector, is a q×1 vector, is a p×1 vector, and and are q×p matrices.
This covariance matrix is a useful tool in many different areas. From it a transformation matrix can be derived, called a whitening transformation, that allows one to completely decorrelate the data or, from a different point of view, to find an optimal basis for representing the data in a compact way (see Rayleigh quotient for a formal proof and additional properties of covariance matrices). This is called principal components analysis (PCA) and the Karhunen-Loève transform (KL-transform).
The joint mean and joint covariance matrix of and can be written in block form
where and .
and can be identified as the variance matrices of the marginal distributions for and respectively.
If and are jointly normally distributed,
then the conditional distribution for given is given by
defined by conditional mean
The matrix of regression coefficients may often be given in transpose form, ΣXX−1ΣXY, suitable for post-multiplying a row vector of explanatory variables xT rather than pre-multiplying a column vector x. In this form they correspond to the coefficients obtained by inverting the matrix of the normal equations of ordinary least squares (OLS).
As a linear operator
Applied to one vector, the covariance matrix maps a linear combination, c, of the random variables, X, onto a vector of covariances with those variables: . Treated as a bilinear form, it yields the covariance between the two linear combinations: . The variance of a linear combination is then , its covariance with itself.
Which matrices are covariance matrices?
From the identity just above, let be a real-valued vector, then
which must always be nonnegative since it is the variance of a real-valued random variable. and the symmetry of the covariance matrix's definition it follows that only a positive-semidefinite matrix can be a covariance matrix. Conversely, every symmetric positive semi-definite matrix is a covariance matrix. To see this, suppose M is a p×p positive-semidefinite matrix. From the finite-dimensional case of the spectral theorem, it follows that M has a nonnegative symmetric square root, that can be denoted by M1/2. Let be any p×1 column vector-valued random variable whose covariance matrix is the p×p identity matrix. Then
How to find a valid correlation matrix
In some applications (e.g., building data models from only partially observed data) one wants to find the "nearest" correlation matrix to a given symmetric matrix (e.g., of observed covariances). In 2002, Higham formalized the notion of nearness using a weighted Frobenius norm and provided a method for computing the nearest correlation matrix.
Complex random vectors
where the complex conjugate of a complex number is denoted ; thus the variance of a complex number is a real number.
If is a column-vector of complex-valued random variables, then the conjugate transpose is formed by both transposing and conjugating. In the following expression, the product of a vector with its conjugate transpose results in a square matrix, as its expectation:
where denotes the conjugate transpose, which is applicable to the scalar case since the transpose of a scalar is still a scalar. The matrix so obtained will be Hermitian positive-semidefinite, with real numbers in the main diagonal and complex numbers off-diagonal.
If and are centred data matrices of dimension n-by-p and n-by-q respectively, i.e. with n rows of observations of p and q columns of variables, from which the column means have been subtracted, then, if the column means were estimated from the data, sample correlation matrices and can be defined to be
or, if the column means were known a-priori,
These empirical sample correlation matrices are the most straightforward and most often used estimators for the correlation matrices, but other estimators also exist, including regularised or shrinkage estimators, which may have better properties.
As a parameter of a distribution
If a vector of n possibly correlated random variables is jointly normally distributed, or more generally elliptically distributed, then its probability density function can be expressed in terms of the covariance matrix.
In financial economics
The covariance matrix plays a key role in financial economics, especially in portfolio theory and its mutual fund separation theorem and in the capital asset pricing model. The matrix of covariances among various assets' returns is used to determine, under certain assumptions, the relative amounts of different assets that investors should (in a normative analysis) or are predicted to (in a positive analysis) choose to hold in a context of diversification.
- Wasserman, Larry (2004). All of Statistics: A Concise Course in Statistical Inference. ISBN 0-387-40272-1.
- William Feller (1971). An introduction to probability theory and its applications. Wiley. ISBN 978-0-471-25709-7. Retrieved 10 August 2012.
- Taboga, Marco (2010). "Covariance matrix". Lectures on probability theory and mathematical statistics.
- Eaton, Morris L. (1983). Multivariate Statistics: a Vector Space Approach. John Wiley and Sons. pp. 116–117. ISBN 0-471-02776-6.
- Higham, Nicholas J. (2002). "Computing the nearest correlation matrix—a problem from finance". IMA Journal of Numerical Analysis 22 (3): 329–343. doi:10.1093/imanum/22.3.329.
- Brookes, Mike. "Stochastic Matrices". The Matrix Reference Manual.
- Hazewinkel, Michiel, ed. (2001), "Covariance matrix", Encyclopedia of Mathematics, Springer, ISBN 978-1-55608-010-4
- Weisstein, Eric W., "Covariance Matrix", MathWorld.
- van Kampen, N. G. (1981). Stochastic processes in physics and chemistry. New York: North-Holland. ISBN 0-444-86200-5.