Abstract
AbstractCorrelations are the main drivers for credit portfolio risk and constitute a major element in pricing credit derivatives such as synthetic single‐tranche collateralized debt obligation swaps. This study suggests a dynamic panel regression approach to model and forecast implied correlations. Random effects are introduced to account for unobservable time‐specific effects on implied tranche correlations. The implied‐correlation forecasts of tranche spreads are compared to forecasts using historical correlations from asset returns. The empirical findings support our proposed dynamic mixed‐effects regression correlation model. © 2013 Wiley Periodicals, Inc. Jrl Fut Mark
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