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Ledoit-Wolf Constant-Correlation Covariance Shrinkage

Hard · portfolio_optimization · Quant Researcher interview question · covariance-estimation, shrinkage, numpy, portfolio-optimization, ledoit-wolf

Sample covariance matrices are often noisy and ill-conditioned, leading to unstable portfolio optimizations. Ledoit-Wolf shrinkage addresses this by combining the sample covariance with a structured, well-behaved target matrix, like the constant-correlation matrix. This technique is a standard tool in quantitative finance for risk management and portfolio construction. Task Implement the function solution(returns: list) -> list that applies Ledoit-Wolf constant-correlation shrinkage to a T x N