PT - JOURNAL ARTICLE
AU - Numpacharoen, Kawee
TI - Weighted Average Correlation Matrices Method for Correlation Stress Testing and Sensitivity Analysis
AID - 10.3905/jod.2013.21.2.067
DP - 2013 Nov 30
TA - The Journal of Derivatives
PG - 67--74
VI - 21
IP - 2
4099 - http://jod.pm-research.com/content/21/2/67.short
4100 - http://jod.pm-research.com/content/21/2/67.full
AB - Stress testing entails pushing risk parameters toward more extreme levels and exploring the impact on portfolio value. But it is not trivial to perturb a correlation matrix while maintaining its necessary properties. All entries on the diagonal must be 1.0; all off-diagonal entries must lie in the interval [–1.0,1.0]; and the matrix has to be symmetric and positive (semi) definite. In this article, Numpacharoen presents a remarkably simple approach for modifying a correlation matrix that maintains its required properties. He proves that the weighted average of two proper correlation matrices will also be a proper correlation matrix, which points the way toward easy procedures for stress testing all, or a subset, of the correlations among a set of securities.