Determining and Allocating Diversification Benefits for a Portfolio of Risks

8 Pages Posted: 13 May 2009

See all articles by Weihao Choo

Weihao Choo

Macquarie University - Department of Applied Finance and Actuarial Studies

Piet De Jong

Macquarie University - Department of Applied Finance and Actuarial Studies; Financial Research Network (FIRN); Macquarie University, Macquarie Business School

Date Written: May, 11 2009

Abstract

A critical problem in risk analysis involving financial variables is the calculation of risk margins. When there are a number of risks, the total risk margin is often reduced to reflect "diversification benefits." How large should the diversification benefit be? And how should the benefit be allocated to the individual risks?. We propose a simple statistical solution. While providing a theoretical analysis, the arrived at expressions are simple to implement in practice. No complex assumptions or simulations are necessarily required.

Keywords: Diversification, Allocated risk margins Stand--alone risk margins, Capital allocation, Euler allocation, Percentile risk aversion

JEL Classification: D81, G12, G22

Suggested Citation

Choo, Weihao and De Jong, Piet, Determining and Allocating Diversification Benefits for a Portfolio of Risks (May, 11 2009). Available at SSRN: https://ssrn.com/abstract=1402992 or http://dx.doi.org/10.2139/ssrn.1402992

Weihao Choo

Macquarie University - Department of Applied Finance and Actuarial Studies ( email )

North Ryde
Sydney, New South Wales 2109
Australia

Piet De Jong (Contact Author)

Macquarie University - Department of Applied Finance and Actuarial Studies ( email )

Sydney, New South Wales
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

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