Insights to systematic risk and diversification across a joint probability distribution

Weihao Choo, Piet de Jong

Research output: Contribution to journalArticleResearchpeer-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.

LanguageEnglish
Pages142-150
Number of pages9
JournalInsurance: Mathematics and Economics
Volume67
DOIs
Publication statusPublished - Mar 2016

Fingerprint

Diversification
Joint Distribution
Probability Distribution
Dependent
Financial Markets
Volatility
Probability distribution
Systematic risk
Euler
Vary

Keywords

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

Cite this

@article{0d3dcdf392954fb8a48b7881ce32f910,
title = "Insights to systematic risk and diversification across a joint probability distribution",
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.",
keywords = "Distortion risk, Spectral risk, Euler allocation, Systematic risk, Diversification, Layer, Value-at-Risk",
author = "Weihao Choo and {de Jong}, Piet",
year = "2016",
month = "3",
doi = "10.1016/j.insmatheco.2015.12.007",
language = "English",
volume = "67",
pages = "142--150",
journal = "Insurance: Mathematics and Economics",
issn = "1873-5959",
publisher = "Elsevier",

}

Insights to systematic risk and diversification across a joint probability distribution. / Choo, Weihao; de Jong, Piet.

In: Insurance: Mathematics and Economics, Vol. 67, 03.2016, p. 142-150.

Research output: Contribution to journalArticleResearchpeer-review

TY - JOUR

T1 - Insights to systematic risk and diversification across a joint probability distribution

AU - Choo,Weihao

AU - de Jong,Piet

PY - 2016/3

Y1 - 2016/3

N2 - 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.

AB - 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.

KW - Distortion risk

KW - Spectral risk

KW - Euler allocation

KW - Systematic risk

KW - Diversification

KW - Layer

KW - Value-at-Risk

UR - http://www.scopus.com/inward/record.url?scp=84957873246&partnerID=8YFLogxK

U2 - 10.1016/j.insmatheco.2015.12.007

DO - 10.1016/j.insmatheco.2015.12.007

M3 - Article

VL - 67

SP - 142

EP - 150

JO - Insurance: Mathematics and Economics

T2 - Insurance: Mathematics and Economics

JF - Insurance: Mathematics and Economics

SN - 1873-5959

ER -