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The Implications of Implied Correlation

by Roy Mashal of Lehman Brothers,
Marco Naldi of Lehman Brothers, and
Gaurav Tejwani of Lehman Brothers

July 2004

Abstract: Implied correlation is increasingly used for relative value considerations when comparing alternative investments in synthetic CDO tranches. Here we show that, by neglecting the heterogeneity of the underlying portfolio, implied correlation may lead to misleading relative value assessments. We argue that a modified implied correlation measure, which we call the "implied correlation bump", may be more appropriate for the relative value analysis of alternative tranched investments.

Keywords: CDO, Implied Correlation.

Published in: RISK, Vol. 17, No. 7, (July 2004), pp. 66-68.

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