Working with the Correlation Setting in the Risk Matrix

As you can include multiple assets in the Risk Matrix, this means that you can also create a risk matrix for:

Instruments with multiple underlying assets, e.g., a spread or a crack.

A portfolio where the instruments are based on different assets and/or which contains instruments with multiple underlying assets.

This is useful as it lets you alter different elements of the different assets according to your view of the market. For example, you can shift the spot of one underlying asset and the volatility of a different underlying asset.

As part of the support for multiple assets, you can also control whether shifting one of the elements will also affect that same element in all the underlying assets in that strategy, and how. You do this using the Correlation fields as seen in Figure 1.

Figure 1: Defining the Correlation Setting in the Risk Matrix

If you select:

Beta0, then the defined shift for an element of the reference underlying asset does not affect the same element in any other assets in the strategy.

Beta1, a defined shift for an element of the reference underlying asset does affect the same element in any other assets in the strategy.

The shift for the other assets is calculated as follows-SD takes the defined shift for the reference asset and calculates it as a percentage of its nearby contract (if it not already defined as a percentage), and that percentage is then applied to the same element in the other assets in the strategy.

BetaCorrelHist, a defined shift for an element of the reference underlying asset does affect the same element in any other assets in the strategy. The shift for each of the other assets is calculated as follows:

X% * (correlation between the reference underlying asset and this asset) * (ATMF vol of this asset/ATMF vol of the reference underlying asset)

Where the X% is calculated as follows–SD takes the defined shift for the reference asset and calculates it as a percentage of the nearby contract (if it not already defined as a percentage).

This option more closely reflects the actual correlation between assets in the market than the Beta1 correlation option does.

It is important to note that if you activate the correlation functionality (by selecting Beta1 or BetaCorrelHist), then this setting will also affect and be affected by the curve setting (as described in Controlling How the Defined Shift Is Applied Across the Curve in the Risk Matrix).