In the core of correlation
The single-factor Gaussian copula model has become a benchmark for the pricing and risk management of basket credit derivatives and synthetic CDO tranches. However, recent months have seen the development of a market for tranched synthetic indexes, indicating a pronounced correlation skew. Assessment of this correlation skew typically assumes equal correlation parameters within the single-factor model. In a follow-up to their I will survive article of last year, Jon Gregory and Jean-Paul Laurent show how to tractably move beyond a flat correlation matrix, allowing a more realistic treatment and analysis of correlation risk
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