Abstract

http://ssrn.com/abstract=1769302
 
 

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A Comparative Analysis of Correlation Approaches in Finance


Gunter A. Meissner


affiliation not provided to SSRN

Claudio Albanese


King's College London - Department of Mathematics; Global Valuation Ltd

David Li


affiliation not provided to SSRN

Edgar Lobackeskiy


affiliation not provided to SSRN

February 24, 2011


Abstract:     
This paper analyses the most widely applied correlation approaches in finance. We first discuss primarily bottom-up approaches, as correlating Brownian motions (Heston 1993), the binomial correlation approach (Lucas 1995), Copulas (Sklar 1959, Li 2000), lattice models with dynamic copulas (Albanese et al. 2005, 2007, 2010), conditionally independent models (Vasicek 1987 and extensions), and the contagion correlation approach (Davis and Lo 1999, Jarrow and Yu 2001). New insights on the Gaussian copula, partly blamed for the global financial crisis 2007/2008 are given. We then discuss top-down approaches as Vasicek’s 1987 large homogeneous portfolio (LHP), inducing correlation in Markov chain models (Hurd and Kuznetsov 2006a, 2006b, Schönbucher 2006), and the top-down contagion model of Giesecke et al 2009. This paper addresses the mathematical properties of the correlation approaches. A follow up paper will empirically test the correlation approaches using default data of the US banking sector before and during the 2007/2008 crisis.

Number of Pages in PDF File: 51

Keywords: Financial Correlations, Top-Down Bottom Up, Copulas, Contagion

JEL Classification: C15, C53

working papers series


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Date posted: February 24, 2011  

Suggested Citation

Meissner, Gunter A. and Albanese, Claudio and Li, David and Lobackeskiy, Edgar, A Comparative Analysis of Correlation Approaches in Finance (February 24, 2011). Available at SSRN: http://ssrn.com/abstract=1769302 or http://dx.doi.org/10.2139/ssrn.1769302

Contact Information

Gunter A. Meissner (Contact Author)
affiliation not provided to SSRN ( email )
Claudio Albanese
King's College London - Department of Mathematics ( email )
Strand
London, UT England WC2R 2LS
United Kingdom
Global Valuation Ltd ( email )
9 Devonshire Sq.
London, London EC2M 4YF
United Kingdom
David Li
affiliation not provided to SSRN
Edgar Lobackeskiy
affiliation not provided to SSRN
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