Cracking the correlation conundrum
A new approach to quoting correlations that removes previous valuation ambiguities is emerging. Base correlations help stifle unscrupulous dealers’ ability to mislead investors about the cheapness of tranches, but they are no panacea. By Navroz Patel
Controversy seems to be a natural characteristic of the credit derivatives market. Cautionary tales – mostly relating to bespoke single-tranche collateralised debt obligations (CDO) and other correlation products – have peppered the pages of Risk in recent years.
And 2004 is no different. The latest flashpoint relates to how dealers quote implied correlation – a quantity that conveys information about relative value in correlation products, similar to the way implied volatility does for options
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