Cutting Edge introduction: Wrong-way risk and the limits of correlation

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Correlation is not causation – a lesson learned at school. It is also not a complete summary of all statistical co-dependence – though that impression could have been forgiven prior to the crisis, when models like the Gaussian copula became the basis for some derivatives markets.

The temptation to focus on correlation is particularly harmful in the case of wrong-way risk – the chance of a borrower’s creditworthiness decreasing while its debt is increasing. Traditional attempts to capture wrong

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