What Is the Risk of ‘Wrong-Way’ Correlation in a Portfolio Margining System?

Wrong-way correlation (WWC) is the risk that the exposure to a counterparty increases at the same time as the counterparty's creditworthiness decreases. In portfolio margining, this means that the risk-reducing correlation assumptions used in the model break down during a market crisis, leading to simultaneous losses on all positions and a massive, unexpected margin shortfall.

WWC is a major tail risk.