Correlation trade is extreme sport for hedge funds

From Reuters,

To strip out the impact of the underlying index, dealers use the concept of correlation, a controversial measure of how the prices of individual components of a portfolio might move given various scenarios such as an individual default or bad news in a particular sector.

Five-year iTraxx correlation is currently around 17 percent, the highest level for 18 months but still below the 22 percent peak seen in April 2005, before the so-called correlation crises sparked by the downgrades of U.S. automakers Ford ... and General Motors...

Correlation is a measure of idiosyncratic risk over systemic risk, and there are no agreed method of measuring it. The general principle is that if correlation is higher, idiosyncratic risk is lower, because it is less likely that an individual company will default.

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