Measuring Sectoral Diversification in an Asymptotic Multi-Factor Framework

Journal of Credit Risk 2(3), 33-55, 2006

23 Pages Posted: 3 Jun 2005 Last revised: 22 Jan 2014

See all articles by Dirk Tasche

Dirk Tasche

Swiss Financial Market Supervisory Authority (FINMA)

Date Written: August 31, 2006

Abstract

We investigate a multi-factor extension of the asymptotic single risk factor (ASRF) model that underlies the capital charges of the "Basel II Accord". In this extended model, it is still possible to derive closed-form solutions for the risk contributions to Value-at-Risk and Expected Shortfall. As an application of the risk contribution formulae we introduce a new concept for a diversification measure. The use of this new measure is illustrated by an example calculated with a two-factor model. The results with this model indicate that, thanks to dependence on not fully correlated systematic sectors, there can be a substantial reduction of risk contributions by sectoral diversification effects.

Keywords: risk contribution, multi-factor model, diversification index

JEL Classification: C14, D81

Suggested Citation

Tasche, Dirk, Measuring Sectoral Diversification in an Asymptotic Multi-Factor Framework (August 31, 2006). Journal of Credit Risk 2(3), 33-55, 2006, Available at SSRN: https://ssrn.com/abstract=733084 or http://dx.doi.org/10.2139/ssrn.733084

Dirk Tasche (Contact Author)

Swiss Financial Market Supervisory Authority (FINMA) ( email )

Einsteinstrasse 2
Bern, 3003
Switzerland

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