Model behaviour

Banks and hedge funds have been facing up to the limitations of their correlation trading models, which were exposed in the aftermath of the autos downgrades in May. Laurence Neville reports on the industry's response to the correlation blowout

The correlation crisis of May has a well-known backdrop. As spreads tightened in the two-and-a-half years prior to the Ford/General Motors (GM) blowout, investors turned their attention to assets such as structured credit that yielded more than bonds. Buyers, largely real-money investors such as insurers, wanted mezzanine tranches - leaving dealers with hefty short positions.

Over the same period, hedge funds also bought structured credit. They were hooked because it enabled them to