Contract Description 

Similar to variance swaps, the correlation swap payoff involves a notional, a realized correlation component and a strike price: 

Correlation swap payoff = Notional * (Realized Correlation - Strike)

 

Example: a 1y correlation swap contract on the constituents of the SX5E index would include the following terms: 

- underlying assets: each of the 50 constituent stocks denoted by S1, S2, ..., SN

- notional - €100 000 per correlation point

- realized correlation: Correl 5   where Correl 6  is the familiar pairwaise coefficient of correlation between the time series Xi and Xj of daily log returns observed in the year following the trade date. 

- strike: 52 correlation points

 

If after one year the arithmetic average of pairwise correlation coefficients between the 50 underlying assets is equal to 58.3 correlation points, the swap seller will pay a net CF of €630 000 to the swap buyer. 

 

 

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