A table of the variances and covariances of a set of variables. Portfolio variance is computed from it and the position weights.
Where you will meet it
Covariance matrix comes up in 14 learning outcome notes across the FRM syllabus.
A few of them:
Sample Moments FRM Part I · Quantitative analysis
“For large n the pair of sample means is approximately bivariate normal, centred on the true means, with the population covariance matrix divided by n.”
Calculating and Applying VaR FRM Part I · Valuation and risk models
“For several underlyings, the equivalent exposures are combined using the covariance matrix.”
Non-Parametric Approaches FRM Part II · Market risk measurement and management
“They need no covariance matrix, and they handle non-linear positions such as options by revaluing them in each historical scenario.”
Portfolio Construction FRM Part II · Risk management and investment management
“Portfolio construction takes four main inputs: alpha forecasts for each asset, a risk model that supplies the covariance matrix of returns, estimates of transaction costs, and an active risk aversion that sets how much risk is accepted for each unit of alpha.”
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