Skill: Correlation Crisis & Tail Risk | Domain: trading/risk-and-portfolio | Category: risk | Level: advanced Tags: correlation, tail-risk, hedging, crisis, regime, diversification

Correlation Crisis & Tail Risk

1. The Correlation Problem

Normal Times vs Crisis

NORMAL REGIME (VIX < 20):
  Correlations are moderate and stable
  Diversification works as expected
  Asset A: +1%  Asset B: -0.3%  Asset C: +0.5%
  Portfolio: smoothed returns ✓

CRISIS REGIME (VIX > 30):
  Correlations spike toward 1.0
  "All correlations go to 1 in a crash"
  Asset A: -5%  Asset B: -4%  Asset C: -6%
  Portfolio: concentrated loss ✗