Correlation

Correlation has been a hot topic over the past decade, wouldn't you agree? Academics are hootin'-n-hollerin' about how correlations shoot up to 1 in times of panic. Delta, gamma, vega, etc.. - neutral portfolios are all based on some form of correlation. Quants are using ever more complex copula functions to model changing correlations. But here's the rub. Anyone that knows how to play rock paper scissors can understand a copula. I'll demonstrate with an example.

A few years ago I was investing money I couldn't afford to lose (because I don't listen to rules until I know how much breaking them costs me). Anyway, at the time, I figured it this way: I'm a long only investor so if I lose my bank loan on stocks that means the economy is really in the dumps. If I lose it ALL that means the stock market has been halted and money is no longer my primary concern.

You see? I understood that a dramatic change in the stock market is going to change how the stock market changes my net worth. I used the verb change in that sentence twice to give you the sense of derivation.

"And if you don't know, now you know.." - Biggie