Hi David et al,
From VAR topics we know if portfolio A is added to B there will some divesification benefit if correlation between A & B is not 1. Let me add some spice to it.
Portfolio A loss distribution approximately resembles normal distribution ( say retail portfolio)
Portfolio B loss distribution has heavy fat tail ( say large corporate portfolio with big single name concentrations. ie big loans to a single obligor)
Say correlation between portfolio A and B is low ( say 0.4)
Q1. In this case will portfolio A enjoy more diversification benefit than B ( given that B has huge tail losses)
Q2. Assuming above is true, if we hedge some of the big tail events (obligor level risk concentrations) in portfolio B will portfolio B get a decent share of diversification benefit.
Regards
Subin
From VAR topics we know if portfolio A is added to B there will some divesification benefit if correlation between A & B is not 1. Let me add some spice to it.
Portfolio A loss distribution approximately resembles normal distribution ( say retail portfolio)
Portfolio B loss distribution has heavy fat tail ( say large corporate portfolio with big single name concentrations. ie big loans to a single obligor)
Say correlation between portfolio A and B is low ( say 0.4)
Q1. In this case will portfolio A enjoy more diversification benefit than B ( given that B has huge tail losses)
Q2. Assuming above is true, if we hedge some of the big tail events (obligor level risk concentrations) in portfolio B will portfolio B get a decent share of diversification benefit.
Regards
Subin