A Consistent Approach to the Term Structure of Correlation

Thursday, February 27, 2020

Common market best practice for pricing off-the-run or bespoke collateralized debt obligation tranches involves mapping implied base correlation surfaces calibrated from actively traded tranches such as those on the CDX or iTraxx.

Over the last few years, research in this area has resulted in a constant stream of improvements and refinements of this process. The term structure approach for base correlation surfaces is an important incremental improvement over commonly used methods for dealing with the maturity dimension of base correlation surfaces.