Correlation & enterprise risk management - Structured Credit Investor

Correlation means the relationship between two or more variables.
In the credit market, it refers to default correlation; i.e. the probability of default of one reference entity or instrument in relation to another or others. The calculation of implied Correlation trading in a credit portfolio requires complex mathematical modelling. However, the market-based pricing of standardised index tranches enables the derivation and trading of implied correlation on those tranches. Tranches are portfolios of credit risk demarcated through a given attachment point (the minimum level of losses to which a tranche is exposed) and a detachment point (the maximum level of losses to which it is exposed) on a broader credit portfolio and are known as equity tranches, mezzanine tranches and senior tranches. On the indices, tranches are traded with standardised attachment and detachment points.