Fair Value

At the time of writing, little is known about the "fair value" of correlation swaps. 

Owing to the typically large number of underlyings, the popular MC engine with or without local volatility surfaces requires an NxN correlation matrix as additional input parameter. 


There are 2 problems with this approach:

1. Practical problem: individual correlation coefficients cannot be implied from listed option markets. 

2. Theoretical problem: even if one could come up with a sensible implied correlation matrix, a meaningfull dynamic replication strategy for the correlation swap payoff would still be missing. 


Ongoing research aims to identify the linkages between dispersion trading and the dynamic hedging of correlation swaps, especially when the underlying assets are the constituent stocks of an equity index. This approach exploits the proxy formulas above to rewrite the correlation swap payoff as a function of tradable variance swaps; in this framework the correlation swap becomes a multiasset volatility derivative, rather than a classical multiasset derivative. 

Add a comment


The NEW website is OUT! 

Go have a look at https://www.derivativesacademy.com.

You will find the content in the 'Derivatives Academy' section in a book format. 
The full content is not yet available as I am rewriting it and improving it.

You can try the Exotic Derivatives pricer under the 'Derivatives Pricer' section (
https://www.derivativesacademy.com/derivatives-pricer/). I will speed up the page soon as I forgot to compress some images.
Each application allows you to price differents products and contains links towards the correct section of the book. 
You will then be able to get practical and theoretical knowledge quite easily.

I teach quite often using the pricer. You can get so much information and answers to your questions thanks to it.

Take advantage of it as much as you can to hone your knowledge!

If you are looking for junior opportunities in the field of market finance. Register yourself on the website. It's free!

If you have any questions, do not hesitate to contact me on info@derivativesacademy.com.