IDEAS home Printed from https://ideas.repec.org/a/cup/anacsi/v19y2025i2p233-256_2.html

Understanding the correlation risk premium

Author

Listed:
  • Dhaene, Jan
  • Linders, Daniël
  • Ling, Biwen
  • Wang, Qian

Abstract

In this paper, we provide a theoretical framework justifying the existence of a correlation risk premium in a market with two traded assets. We prove that risk-neutral dependence can differ substantially from real-world dependence by characterizing the set of risk-neutral martingale measures. This implies that implied correlation can be significantly different with the realized correlation. Depending on the choice of the market regarding the pricing measure, implied correlation can be high or low. We label the difference between risk-neutral and real-world correlation the “correlation gap” and make the connection with correlation risk premium. We show how dispersion trading can be used to exploit this correlation gap and demonstrate how there can exist a negative correlation risk premium in the financial market.

Suggested Citation

  • Dhaene, Jan & Linders, Daniël & Ling, Biwen & Wang, Qian, 2025. "Understanding the correlation risk premium," Annals of Actuarial Science, Cambridge University Press, vol. 19(2), pages 233-256, July.
    • Handle: RePEc:cup:anacsi:v:19:y:2025:i:2:p:233-256_2
    as

    Download full text from publisher

    File URL: https://www.cambridge.org/core/product/identifier/S1748499524000228/type/journal_article
    File Function: link to article abstract page
    Download Restriction: no
    ---><---

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cup:anacsi:v:19:y:2025:i:2:p:233-256_2. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Kirk Stebbing (email available below). General contact details of provider: https://www.cambridge.org/aas .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.