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arXiv · 0908.4299

Correlation breakdown, copula credit default models and arbitrage

Rodanthy Tzani·Alexios P. Polychronakos
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Abstract

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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Rodanthy Tzani, Alexios P. Polychronakos. 2009-08-31. Correlation breakdown, copula credit default models and arbitrage. https://arxiv.org/abs/0908.4299

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