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Working paper

Dynamic implied correlation modeling and forecasting in structured finance

Markets Finance Global Financial Crisis (2008-2009)
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apo-nid66240.pdf 1.58 MB

The market volume of credit derivatives increased rapidly from $180 billion in 1996 to over $57 trillion in 2008 (BBA, 2006; BIS, 2010). This growth rate highlights the importance of these new instruments in nancial markets.
Consequences of the global nancial crisis (GFC), e.g., the Lehman Brothers' bankruptcy in 2008, underline the challenge to aggregate individual risk contributions in the presence of correlations, which is essential for pricing
credit derivatives such as collateralized debt obligations (CDOs). The GFC has shown that pooling and tranching within CDO structures amplify errors in the assessment of underlying asset default risks and correlations (compare
Coval et al., 2009).

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