Correlation Skew v Matrix

duin1 · October 6th, 2004, 8:59 am

Hello, I am wondering if anyone can help me please. 1)Would someone be able to tell me the difference between using a correlation skew and correlation matrix when pricing CDO tranches? 2)What is the better way to calculate correlation?3)What is the difference between these and using a flat correlation?4)What is the way correlation is currently calculated in traded tranches in the market?I am trying to come to terms with this concept and any help anyone would be able to pass on would be most appreciated.Best RegardsD

duin1 · October 6th, 2004, 12:03 pm

Anyone out there, I would really appreciate some feedback?

Wibble · October 6th, 2004, 1:17 pm

A correlation matrix is used to capture co-dependence in structured products.Given a price for a structured product, you can imply a correlation for itCorrelation skew is the fact that the prices of different tranches of a CDO give you different implied correlations, there can be many reasons for this.If you got no correlation skew for the tranche prices, then congratulations on probably having a very good model, but you'd better still quote using a gaussian copula for now.Equity correlation works pretty well, there are various papers on this

duin1 · October 6th, 2004, 1:24 pm

Would you have any links to such articles that a layman might be able to learn from

Wibble · October 6th, 2004, 1:28 pm

There are stacks of papers on defaultrisk.com, a lot are about pricing CDOs, but most have some background info on them. Best resource is banks research papers, Merrils, Lehmans and JPs publish quite a lot. Some of the papers have been posted on various threads on the forum, do a search for CDO and you should find quite a few, Lee McGinty of JPs published an article on using base correlation here

duin1 · October 6th, 2004, 1:35 pm

thanks

ariba1615 · June 1st, 2006, 2:03 pm

What is correlation skew in CDOs ?. Does pricing models based on Guassian copula calibrate for market correlation skews ?. Any information is appreciated.

sammus · June 1st, 2006, 2:11 pm

Does the corr skew exist in the equity dispersion trading as well?