How is realized pairwise correlation computed?

rho_realized = (sigma_index^2 - sum_i w_i^2 * sigma_i^2) / (2 * sum_{i<j} w_i*w_j * sigma_i*sigma_j), where w_i are index weights and sigma_i are realized vols. Approximated from index and stock realized variances.

Why does the correlation risk premium typically cause implied > realized?

Investors pay a premium for index puts, which implicitly require high correlation. This pushes up implied correlation above realized levels on average, creating the correlation risk premium.

Realized vs Implied Correlation Trade Calculator

Compute the payoff and fair value of a correlation swap: pays realized average pairwise correlation vs. fixed implied correlation strike. Enables direct trading of the correlation risk premium.

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$ Finance Disclaimer: These calculators are for educational and illustrative purposes only. Results do not constitute financial advice. Consult a licensed financial advisor before making investment or borrowing decisions.

How to Use

Enter the values for the scenario you are assessing. Compute the payoff and fair value of a correlation swap: pays realized average pairwise correlation vs. fixed implied correlation strike. Enables direct trading of the correlation risk premium. Use the correlation trade rvi result to inform your calculation.

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Realized vs Implied Correlation Trade Calculator

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Frequently Asked Questions

How is realized pairwise correlation computed?

Why does the correlation risk premium typically cause implied > realized?