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The Impact of Systemic Risk on the Diversification Benefits of a Risk Portfolio

Listed author(s):
  • Marc Busse

    ()

    (SCOR SE, 26 General Guisan Quai, 8022 Zürich, Switzerland)

  • Michel Dacorogna

    ()

    (SCOR SE, 26 General Guisan Quai, 8022 Zürich, Switzerland)

  • Marie Kratz

    ()

    (ESSEC Business School Paris, CREAR, av. Bernard Hirsch BP 50105, 95021 Cergy-Pontoise Cedex, France)

Risk diversification is the basis of insurance and investment. It is thus crucial to study the effects that could limit it. One of them is the existence of systemic risk that affects all of the policies at the same time. We introduce here a probabilistic approach to examine the consequences of its presence on the risk loading of the premium of a portfolio of insurance policies. This approach could be easily generalized for investment risk. We see that, even with a small probability of occurrence, systemic risk can reduce dramatically the diversification benefits. It is clearly revealed via a non-diversifiable term that appears in the analytical expression of the variance of our models. We propose two ways of introducing it and discuss their advantages and limitations. By using both VaR and TVaR to compute the loading, we see that only the latter captures the full effect of systemic risk when its probability to occur is low.

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Article provided by MDPI, Open Access Journal in its journal Risks.

Volume (Year): 2 (2014)
Issue (Month): 3 (July)
Pages: 1-17

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Handle: RePEc:gam:jrisks:v:2:y:2014:i:3:p:260-276:d:37965
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  1. repec:fip:fedhpr:y:2010:i:may:p:65-71 is not listed on IDEAS
  2. Martinez-Miera, David & Suarez, Javier, 2012. "A Macroeconomic Model of Endogenous Systemic Risk Taking," CEPR Discussion Papers 9134, C.E.P.R. Discussion Papers.
  3. Viral V. Acharya & Lasse H. Pedersen & Thomas Philippon & Matthew Richardson, 2010. "Measuring systemic risk," Working Paper 1002, Federal Reserve Bank of Cleveland.
  4. Darrell Duffie, 2013. "Systemic Risk Exposures: A 10-by-10-by-10 Approach," NBER Chapters,in: Risk Topography: Systemic Risk and Macro Modeling, pages 47-56 National Bureau of Economic Research, Inc.
  5. Giglio, Stefano & Kelly, Bryan & Pruitt, Seth, 2016. "Systemic risk and the macroeconomy: An empirical evaluation," Journal of Financial Economics, Elsevier, vol. 119(3), pages 457-471.
  6. repec:hal:journl:hal-00921283 is not listed on IDEAS
  7. Monica Billio & Mila Getmansky & Andrew W. Lo & Loriana Pelizzon, 2010. "Econometric Measures of Systemic Risk in the Finance and Insurance Sectors," NBER Chapters,in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
  8. Rama Cont & Amal Moussa & Edson B Santos, 2013. "Network structure and systemic risk in banking systems," Post-Print hal-00912018, HAL.
  9. Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
  10. Susanne Emmer & Dirk Tasche, 2003. "Calculating credit risk capital charges with the one-factor model," Papers cond-mat/0302402, arXiv.org, revised Jan 2005.
  11. Susanne Emmer & Marie Kratz & Dirk Tasche, 2013. "What is the best risk measure in practice? A comparison of standard measures," Papers 1312.1645, arXiv.org, revised Apr 2015.
  12. Viral V. Acharya, 2010. "Measuring systemic risk," Proceedings 1140, Federal Reserve Bank of Chicago.
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