Boundaries of Correlation Adjustment with Applications to Financial Risk Management

Kawee Numpacharoen and Kornkanok Bunwong

Applied Mathematical Finance, 2013, vol. 20, issue 4, 403-414

Abstract: In recent years, stress testing has become a regulatory requirement for risk assessment in financial institutions. To perform stress testing in multi-asset case, adjusting the correlation matrix to an extreme level is an important process. With a larger matrix, it is more difficult to choose the right correlation coefficients such that the newly adjusted correlation matrix is still valid. In this article, we present a systematic way to obtain the boundaries of a correlation matrix for both single stress and multiple stress cases, which can help determine how much the correlation should be adjusted in the first place.

Date: 2013
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DOI: 10.1080/1350486X.2012.723517

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