Sep 25

Risk contribution (RC) of credit asset to portfolio unexpected loss – 8 min briefcast

by David Harper, CFA, FRM, CIPM

FRM |

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Here is a review of risk contribution (RC). Please note:

  • Yet another first partial derivative: this is a sensitivity measure of the individual credit asset’s contribution to portfolio unexpected loss.
  • Risk contribution is analogous to systematic risk in single-factor (capital asset pricing model): as Ong says, it is a measure of the “undiversified risk of an asset in the portfolio. It is the amount of credit risk which cannot be diversified away by placing the asset in the portfolio.” See the analogy? In CAPM, beta captures the asset’s risk which cannot be diversified away.
  • The sum of individual asset risk contributions = portfolio unexpected loss. This also makes RC analogous to Jorion’s component value at risk (component VaR; where sum of component VaRs = portfolio VaR).
  • Similarly, the sum of individual asset unexpected loss will be greater than (>) portfolio unexpected loss

Screencast:

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