Mathematics

Cholesky Decomposition

The factorisation of a positive definite matrix into a lower triangular matrix times its transpose.

A = LL'. Roughly twice as fast as a general LU decomposition and numerically stable for positive definite matrices.

The main practical use in finance: generating correlated random variables. Draw independent standard normals z, then Lz has covariance A. That is how correlated Monte Carlo paths are simulated.

A useful diagnostic. The decomposition fails - you take a square root of a negative number - exactly when the matrix is not positive definite, so attempting it is a fast validity check on an estimated covariance matrix.

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