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Explanation:
In a correlation swap, the realized correlation is calculated as the arithmetic average of all the realized pairwise correlations among the underlying assets over the observation period.
For 3 assets, there are 3 distinct pairwise correlations: , , and .
Realized correlation =
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Q.24 The buyer of a correlation swap with three assets and a maturity of one year pays a fixed rate of 2.5%. The notional amount of the swap is $1 million. If the realized pairwise correlations of the daily log returns for the three assets are ρ₂,₁ = 0.2, ρ₃,₁ = 0.4 and ρ₃,₂ = 0.3, what is the realized correlation?
A
0.30
B
0.20
C
0.45
D
0.16