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Risk factor contributions in portfolio credit risk models

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  • Rosen, Dan
  • Saunders, David
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    Abstract

    Determining contributions to overall portfolio risk is an important topic in risk management. For positions (instruments and sub-portfolios), this problem has been well studied, and a significant theory built, around the calculation of marginal contributions. We consider the problem of determining the contributions to portfolio risk of risk factors. This cannot be addressed through an immediate extension of techniques for position contributions, since the portfolio loss is a nonlinear function of the risk factors. We employ the Hoeffding decomposition of the portfolio loss into a sum of terms depending on the factors. This decomposition restores linearity, but includes terms arising from joint effects of groups of factors. These cross-factor terms provide information to risk managers, since they can be viewed as best hedges of the portfolio loss involving instruments of increasing complexity. We illustrate the technique on multi-factor portfolio credit risk models, where systematic factors represent industries, geographical sectors, etc.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 34 (2010)
    Issue (Month): 2 (February)
    Pages: 336-349

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    Handle: RePEc:eee:jbfina:v:34:y:2010:i:2:p:336-349

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Risk contributions Risk measures Portfolio credit risk Hoeffding decomposition;

    References

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    1. C. Gourieroux & J.P. Laurent & O. Scaillet, 2000. "Sensitivity analysis of values at risk," THEMA Working Papers 2000-04, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
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    3. Adam, Alexandre & Houkari, Mohamed & Laurent, Jean-Paul, 2008. "Spectral risk measures and portfolio selection," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1870-1882, September.
    4. Gordy, Michael B., 2003. "A risk-factor model foundation for ratings-based bank capital rules," Journal of Financial Intermediation, Elsevier, vol. 12(3), pages 199-232, July.
    5. Dirk Tasche, 2005. "Measuring sectoral diversification in an asymptotic multi-factor framework," Papers physics/0505142, arXiv.org, revised Jul 2006.
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    7. Bellini, Fabio & Rosazza Gianin, Emanuela, 2008. "On Haezendonck risk measures," Journal of Banking & Finance, Elsevier, vol. 32(6), pages 986-994, June.
    8. Susanne Emmer & Dirk Tasche, 2003. "Calculating credit risk capital charges with the one-factor model," Papers cond-mat/0302402, arXiv.org, revised Jan 2005.
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    10. Lemieux, Christiane & L’Ecuyer, Pierre, 2001. "On selection criteria for lattice rules and other quasi-Monte Carlo point sets," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 55(1), pages 139-148.
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    13. Sandro Merino & Mark Nyfeler, 2004. "Applying importance sampling for estimating coherent credit risk contributions," Quantitative Finance, Taylor & Francis Journals, vol. 4(2), pages 199-207.
    14. Medema, Lydian & Koning, Ruud H. & Lensink, Robert, 2009. "A practical approach to validating a PD model," Journal of Banking & Finance, Elsevier, vol. 33(4), pages 701-708, April.
    15. Dirk Tasche, 2007. "Capital Allocation to Business Units and Sub-Portfolios: the Euler Principle," Papers 0708.2542, arXiv.org, revised Jun 2008.
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    Cited by:
    1. Arvid Raknerud & Bjørn Helge Vatne, 2013. "The relations between bank-funding costs, retail rates, and loan volumes. Evidence form Norwegian microdata," Discussion Papers 742, Research Department of Statistics Norway.
    2. Aussenegg, Wolfgang & Resch, Florian & Winkler, Gerhard, 2011. "Pitfalls and remedies in testing the calibration quality of rating systems," Journal of Banking & Finance, Elsevier, vol. 35(3), pages 698-708, March.
    3. Buch, Arne & Dorfleitner, Gregor & Wimmer, Maximilian, 2011. "Risk capital allocation for RORAC optimization," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3001-3009, November.
    4. Lee, Yongwoong & Poon, Ser-Huang, 2014. "Forecasting and decomposition of portfolio credit risk using macroeconomic and frailty factors," Journal of Economic Dynamics and Control, Elsevier, vol. 41(C), pages 69-92.

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