A bottom-up model with top-down dynamics

The recent volatility in the synthetic collateralised debt obligation (CDO) market underscores the need for more consistent models beyond the standard base correlation model, whose drawbacks are well understood and documented. Much effort has been devoted to the development of proper dynamic correlation models.

There are two main types of dynamic correlation models in the literature: the top-down approach (for example, Sidenius, Piterbarg & Andersen, 2006, and Schonbucher, 2006) and the bottom-u