Mastering the Dimensions of Correlations

Calibrating Economic Scenario Generators to realistic correlation structures can be difficult and time-consuming, especially as the dimensions of the models increase. Practitioners are often forced to follow a “partial approach” in which they calibrate models on an application-specific subset of the correlation dimensions. Although understandable, such a partial approach to correlation modeling is inefficient and inconsistent. In this paper, we discuss the various dimensions of correlations, and illustrate how these can be mastered with the help of well-designed and calibrated risk models.

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