Financial Correlation Modelling - Bottom Up approaches

Question 1

Copula correlation

Answer 1

Created by converting two or more unknown distributions that have unique shapes and mapping them to a known distribution with a well defined properties, such as the normal distribution.

Accomplished by mapping multiple distributions to a single multivariate distribution.

Question 2

Copula functions

Answer 2

Fell out of favor once the 2007-2009 crisis began.

Question 3

Copula function

Answer 3

C|G1(u1)…Gn(un)|=Fn{F1^(-1)(G1(u1)…Fn^(-1)(Gn(un)))

Question 4

Copula function parameters

Answer 4

G»Marginal distributions, univariate uniform distribution, belongs to [0,1]

F» Joint cumulative distribution function

F^-1» Inverse function of F

Rho&raquo_space; Correlation matrix structure of the joint cumulative function

Question 5

Gaussian Copula

Answer 5

Gaussian Copula maps the marginal distribution of each variable to the standard normal distribution, which, by definition, has a mean of zero and a standard deviation of one.

Used to calculate probability of default

Question 6

Cholesky decomposition

Answer 6

Default time, what is time in which bond will default given probability of default