In reading a few different studies I am interested in how implied correlation between assets is calculated. I understand the calculation of basic correlation of a portfolio using historical methods, but that is about the extent of it. I am not sure how to implement the use of the implied volatility from options on the underlying as the volatility input and therefore the correlation input in a value at risk model.An example or real life calculation would help greatly.If I have 5 stocks, some spot commodity positions (via ETF), and some other traditional asset holdings, how do I find the implied correlation of the portfolio and which implied volatility input is appropriate?Any help is appreciated.

check out the following:http://www.cboe.com/micro/impliedcorrel ... =460080HTH

the short answer is that you need to be able to observe the price of a derivative contract which relates two or more assets to be able to figure out what the market's price for the correlation between the returns of those assets is. for example, if you look at the price of EURJPY options and you know the prices of EURUSD and USDJPY options then you can figure out the implied correlation between EURUSD and USDJPY.

My 2 centsOther possible approaches are modelling correlation as a stochastic processhttp://www-num.math.uni-wuppertal.de/fileadmin/mathe/www-num/preprints/amna_06_03.pdfand prof Wilmott discusses Uncertain Correlation in his book. AFAIK you do have to give an interval bound for the extreme values.

dynamic conditional corr (DCC) or Wishart

QuoteOriginally posted by: daveangelthe short answer is that you need to be able to observe the price of a derivative contract which relates two or more assets to be able to figure out what the market's price for the correlation between the returns of those assets is. for example, if you look at the price of EURJPY options and you know the prices of EURUSD and USDJPY options then you can figure out the implied correlation between EURUSD and USDJPY.I agree with Dave on this.Implied correlation is the same sort of thing as implied vol, you have to back it out of asset prices