A Note on Implied Correlation for Bivariate Contracts
Economics Bulletin, 2020, Vol. 40, Issue 2, pp. 1388-1396
10 Pages Posted: 15 Mar 2021
Date Written: May 19, 2020
In this paper we develop a framework in which implied correlation can be rigorously defined for a class of derivative contracts written on two assets. Within this class, we show that implied correlation exists and is unique provided that the observed two-asset contract price is free of arbitrage. We also obtain an analytic result to compute the sensitivity to implied correlation of a contract's price. We then provide a numerical illustration of these results applied to spread options.
Keywords: Bivariate Contracts, Implied Correlation, Risk Management
JEL Classification: G13, C52
Suggested Citation: Suggested Citation