Insights to systematic risk and diversification across a joint probability distribution

Weihao Choo*, Piet de Jong

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

This paper analyses and develops insights to systematic risk and diversification when random, imperfectly dependent, losses are aggregated. Systematic risk and diversification are shown to vary across layers of component losses according to local dependence and volatility structures. Systematic risk is high and diversification is weak overall if high risk layers are heavily dependent on the aggregate loss. This result explains weak diversification observed in financial markets despite weak to moderate correlations overall. A coherent risk setup is assumed in this paper, where risks are measured using distortion and allocated using the Euler principle.

Original languageEnglish
Pages (from-to)142-150
Number of pages9
JournalInsurance: Mathematics and Economics
Volume67
DOIs
Publication statusPublished - Mar 2016

Keywords

  • Distortion risk
  • Spectral risk
  • Euler allocation
  • Systematic risk
  • Diversification
  • Layer
  • Value-at-Risk

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