Collateral Volatility Correlation

Collateral volatility correlation is the measure of how the prices of different assets used as collateral move in relation to one another during market stress. When assets have high positive correlation, they tend to crash together, which increases the risk of simultaneous liquidation across the protocol.

If a lending platform accepts multiple correlated assets, a market downturn can hit all collateral types at once, severely limiting the protocol's ability to remain solvent. Understanding these correlations is critical for setting appropriate loan-to-value ratios.

Ignoring these dynamics can lead to unexpected exposure when diversification fails during a liquidity crisis.