TY - JOUR
T1 - Weighted Average Correlation Matrices Method for Correlation Stress Testing and Sensitivity Analysis
JF - The Journal of Derivatives
SP - 67
LP - 74
DO - 10.3905/jod.2013.21.2.067
VL - 21
IS - 2
AU - Numpacharoen, Kawee
Y1 - 2013/11/30
UR - http://jod.pm-research.com/content/21/2/67.abstract
N2 - 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.
ER -