Hi David,
In the Ong reading on Portfolio Effects, the author said "risk contribution is the single most important measure in credit portfolio management". The reasons given are
1. It enables the risk profile of the portfolio to be modified by changing the risk characteristics of an asset
2. better management of return on asset
Although Ong has not elaborated the two reasons, i infer in regards to #1 that by choosing assets that have lower default correlations with each other, this reduces the risk contributions of assets and hence the overall portfolio unexpected loss is reduced. Diversification, according to Ong, is a more effective way to reduce portfolio default risk compared to the use of credit derivatives and securitisation which shifts the credit risk rather than hedging it away totally.
In regards to #2, my thoughts are risk contributions allows economic capital to be allocated to different business units and hence enable the risk-return evaluation of projects and performance measurements of business units to be evaluated by the use of risk measures like RAROC vis-a-vis the return on equity required by shareholders.
What are your views on this?
Thanks
Regards,
Peggy
In the Ong reading on Portfolio Effects, the author said "risk contribution is the single most important measure in credit portfolio management". The reasons given are
1. It enables the risk profile of the portfolio to be modified by changing the risk characteristics of an asset
2. better management of return on asset
Although Ong has not elaborated the two reasons, i infer in regards to #1 that by choosing assets that have lower default correlations with each other, this reduces the risk contributions of assets and hence the overall portfolio unexpected loss is reduced. Diversification, according to Ong, is a more effective way to reduce portfolio default risk compared to the use of credit derivatives and securitisation which shifts the credit risk rather than hedging it away totally.
In regards to #2, my thoughts are risk contributions allows economic capital to be allocated to different business units and hence enable the risk-return evaluation of projects and performance measurements of business units to be evaluated by the use of risk measures like RAROC vis-a-vis the return on equity required by shareholders.
What are your views on this?
Thanks
Regards,
Peggy