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Correlation breakdown, copula credit default models and arbitrage

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  • Rodanthy Tzani
  • Alexios P. Polychronakos

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.

Suggested Citation

  • Rodanthy Tzani & Alexios P. Polychronakos, 2009. "Correlation breakdown, copula credit default models and arbitrage," Papers 0908.4299, arXiv.org.
    • Handle: RePEc:arx:papers:0908.4299
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    File URL: http://arxiv.org/pdf/0908.4299
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