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Implied Correlation

  1. Jul 3, 2012 #1

    Haven't studied math for a while and thought I'd ask you for help. It regards implied correlation based on implied volatility for FX options.


    Var(b/c) = Var(a/c)+Var(a/b) - 2*Sigma(a/c)*Sigma(a/b)*Corr(a/c,a/b)

    When breaking out the Corr(a/c,a/b) from the formula, we get the following:

    Corr(a/c,a/b) = (Var(a/c)+Var(a/b)-Var(b/c)) / (2*Sigma(a/c)*Sigma(a/b))

    Now let's break out (a/c)

    (a/c) = (b/c) * (a/b)

    Now I have understood that the Corr(b/c,a/b) formula is the following

    Corr(b/c,a/b) = (Var(a/c)-Var(b/c)-Var(a/b)) / (2*Sigma(b/c)*Sigma(a/b))

    Does this mean the Var(a/c) formula is like the following

    Var(a/c) = Var(b/c)+Var(a/b) + 2*Sigma(b/c)*Sigma(a/b)*Corr(b/c,a/b) ?

    I.e. you have a PLUS instead of a MINUS infront of the 2*Sigma*Sigma*Corr part?

    Happy if someone could answer this.
  2. jcsd
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