Correlation Products and Risk Management Issues

14 Pages Posted: 11 Nov 2007

Abstract

Unlike standard derivatives instruments, correlation products contain nonseparable risk, meaning that the price sensitivity of one risk factor is a function of the level of another risk factor. This article outlines the pricing and hedging of one type of correlation product, the differential swap, to show how nonseparable risk may escape traditional methods of assessing the risk of institutions' portfolios. The article considers the implications of correlation products for supervisory and institutional practices and concludes with a brief discussion of some ways nonseparable risk may be managed.

Keywords: differential swap, nonseparable risk

JEL Classification: G11, G12, G15

Suggested Citation

Mahoney, James M., Correlation Products and Risk Management Issues. Economic Policy Review, Vol. 1, No. 3, October 1995. Available at SSRN: https://ssrn.com/abstract=1028819

James M. Mahoney (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-8910 (Phone)
212-720-1577 (Fax)

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