Fitch Ratings has come out with what is believed to be the first study comparing different correlation methodologies. The research piece looks at the pros and cons of alternative assumptions used by market participants and finds that market-based methodologies are more accurate than rating agency-based one. "At first glance, it sounds curious," acknowledged said Ahmet Kocagil, managing director and global head of quantitative financial research group, which conducted the study. "But when we explain what we are saying, they understand," he said, of investors and the study's conclusion that Fitch's correlation methodologies are more in tune with market concentrations than those of its competitors because Fitch uses equity-based metrics.
Although correlation trading and methodologies are very topical issues, Kocagil said the primary motivation for the study is to offer evidence to Fitch's asset class teams to ensure they use methodology consistent with the empirical facts of the market, he said. The Fitch report comes about four months after Wachovia Securities published research criticizing the rating agencies for their correlation assumptions and even suggested Standard & Poor's keeps liberal levels to win collateralized debt obligation rating business (BW, 2/18).
The Fitch quantitative financial research group was set up at the end of last year with two professionals and now is a staff of seven. It acts as an internal think tank for Fitch's various asset class teams, such as the CDO team, Kocagil said.