Financial Correlation Modelling – Bottom-up Approaches

Gunter Meissner

“Fortune sides with him who dares”

– Virgil

In this chapter we address correlation models, which were specifically designed to measure the association between financial variables. We will concentrate on bottom-up correlation models that collect information, quantify it and then aggregate the information to derive an overall correlation result.


One of the most widely applied correlation approaches used in finance was generated by Steven Heston in 1993. Heston applied the approach to negatively correlate stochastic stock returns dS(t)/S(t) and stochastic volatility σ(t). The core equations of the original Heston model are the two stochastic differential equations (SDEs)

  dS( t ) S( t ) =μdt+σ(t)d z 1 (t) (5.1)


  d σ 2 ( t )=a[ m σ 2 σ 2 ( t ) ]dt+ξσ(t)d z 2 (t) (5.2)


S: variable of interest, eg, a stock price

µ: expected growth rate of S

σ: expected volatility of S

dz: standard Brownian motion, ie, dz( t )=ε( t ) dt ,εt is i.i.d. (independently and identically distributed). In particular ε(t) is a random drawing from a

Sorry, our subscription options are not loading right now

Please try again later. Get in touch with our customer services team if this issue persists.

New to View our subscription options

You need to sign in to use this feature. If you don’t have a account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here