Background Risk Models and Stepwise Portfolio Construction
Methodology and Computing in Applied Probability, 2016, 18(3), 805-827.
27 Pages Posted: 4 Oct 2013 Last revised: 10 Aug 2016
Date Written: April 2, 2015
Assuming the multiplicative background risk model, which has been a popular model due to its practical applicability and technical tractability, we develop a general framework for analyzing portfolio performance based on its subportfolios. Since the performance of subportfolios is easier to assess, the herein developed stepwise portfolio construction (SPC) provides a powerful alternative to a number of traditional portfolio construction methods. Within this framework, we discuss a number of multivariate risk models that appear in the actuarial and financial literature. We provide numerical and graphical examples that illustrate the SPC technique and facilitate our understanding of the herein developed general results.
Keywords: Portfolio construction, Background risk, Systemic risk, Laplace transform, Risk management, Capital allocation
JEL Classification: C44, C51, G22
Suggested Citation: Suggested Citation