Implied Correlations of iTraxx Tranches during the Financial Crisis

Implied Base Correlations of Single-tranche CDOs on standardized Credit Indices such asthe iTraxx Europe have been used in the credit derivatives market for price communication.During the financial crisis, implied correlations have been quite volatile indicating thegrowing fraction of systematic credit risk of STCDOs. This paper analyses the determinantsof tranche implied base correlations for the period September 2006 until April 2009.It will be shown that realized asset correlations between iTraxx Europe corporates are notable to explain the extreme movements of tranche implied correlations during the financialcrisis. Additionally, it will be seen that the worsening creditworthiness of market participantsin the interbank market as well as growing pressure on their refinancing conditionscorrelated significantly with the development of implied base correlations of iTraxxtranches...