What does realized correlation in correlation swaps signify?

Realized correlation in correlation swaps refers to the actual correlation observed over a specified period between the underlying assets involved in the swap. To calculate this realized correlation, a specific formula is used that reflects the number of asset pairs and their correlations.

The formula represented in the correct choice involves taking the double of the number of pairs (since correlation is symmetric) and dividing by the total number of unique pairs of observations, represented mathematically as ( n(n-1) ) for n assets. This approach accurately reflects the aggregate relationship present in the dataset.

This method ensures the calculation accounts for all combinations of asset correlations, making it a robust measure of the realized correlation among the assets over the designated time frame. By incorporating the factor of 2 and adjusting for the total number of pairs, this approach provides a comprehensive view of how the assets correlate, which is crucial in understanding the risk profile of the correlated instruments in financial markets.