Correlation breakdown, copula credit default models and arbitrage

Details Correlation breakdown, copula credit default models and arbitrage Correlation breakdown, copula credit default models and arbitrage

2009-08-31

arxiv.org/abs/0908.4299v1

Published in Global Association of Risk Professionals Magazine, December 2008 Issue, p.37

Economy

Quantitative Finance

Pricing of Securities

15 pages

Scientific paper

The recent "correlation breakdown" in the modeling of credit default swaps, in which model correlations had to exceed 100% in order to reproduce market prices of supersenior tranches, is analyzed and argued to be a fundamental market inconsistency rather than an inadequacy of the specific model. As a consequence, markets under such conditions are exposed to the possibility of arbitrage. The general construction of arbitrage portfolios under specific conditions is presented.

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