Correlation

Definition

Correlation in Risk Management context denotes any one from a class of quantitative measures of Dependency between different risk realizations. Its precise meaning and calculation varies depending on the risk area.

Usage

• In Credit Risk context, more specifically in Credit Portfolio Management correlation is a measure of credit risk dependency between different credit exposures. It may refer to either Default Correlation or Loss Correlation and can be either empirical (based on historical data) or Implied Correlation based on traded instruments.
• In Market Risk context correlations is a measure of the co-movement of prices for traded instruments. It may refer to empirical correlation estimates based on market Timeseries Data or implied correlations based on traded instruments
• Correlation has also be discussed in Operational Risk context

Issues and Challenges

• Excessive focus on the simpler correlation measures can misrepresent the true nature of the dependency
• Empirical estimates of correlation tend to be unstable
• Correlations are particularly difficult to establish for risk types such as operational risk
• Correlation versus Causation

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