The implications of implied correlation

Using implied correlations for evaluating the relative attractiveness of alternative tranched investments has some potential drawbacks. Roy Mashal, Marco Naldi and Gaurav Tejwani explain why

Synthetic collateralised debt obligations (CDOs) are instruments whose payouts are linked to the performance of a portfolio of synthetic credit exposures. This market has experienced continuous innovation over the past few years. While in the early days synthetic CDOs were mainly used by banks for capital relief, most of the issuance is now generated by the dealer community in the form of one-off, bespoke tranches referencing investment-grade credit default swaps. These structures allow for a