Correlation Risk Modelling and Management (2nd Edition)
First published:
ISBN: 978-1-78272-405-6
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Answers to Questions and Problems in Correlation Risk Modelling and Management
Introduction
Correlation Basics: Definitions, Applications and Terminology
Empirical Properties of Correlation: How do Correlations Behave in the Real World?
The Pearson Correlation Model – Work of the Devil?
Cointegration – A Superior Concept to Correlation?
Financial Correlation Modelling – Bottom-up Approaches
Valuing CDOs with the Gaussian Copula – What Went Wrong?
The One-Factor Gaussian Copula Model – Too Simplistic?
Financial Correlation Models – Top-Down Approaches
Stochastic Correlation Models
Quantifying Market Correlation Risk
Quantifying Credit Correlation Risk
Hedging Correlation Risk
Correlation Trading Strategies – Opportunities and Limitations
Credit Value at Risk under Basel III – Too Simplistic?
Basel III and XVAs
Fundamental Review of the Trading Book
The Future of Correlation Modelling
Answers to Questions and Problems in Correlation Risk Modelling and Management
Answers to Questions and Problems of Chapter 1: Correlation Basics: Definitions, Applications and Terminology
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What two types of financial correlations exist?
We differentiate (a) static financial correlations, which measure how two or more financial assets are associated within a certain time period, and (b) dynamic financial correlations, which measure how two or more financial assets move together in time.
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What is “wrong-way correlation risk” or for short “wrong-way risk”?
Wrong-way risk exists when there is a tendency for both the credit exposure and the credit risk to increase. For example, wrong-way risk exists if Deutsche Bank sells a put on itself. In this case the put buyer has wrong-way risk: if the Deutsche Bank stock decreases in price, the credit exposure increases (since the put is more valuable). But, if the Deutsche Bank stock decreases in price, this typically also means that the default probability of Deutsche Bank increases; hence the credit risk for the put buyer with respect to Deutsche Bank also increases.
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Correlations can be non-monotonous. What does this mean?
It means that the value of a variable such as a credit default swap (CDS) or a
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