Risk Decomposition of Investment Portfolios
Northfield

Conclusions
•
How much risk we allocate to a given factor is heavily influenced by the estimation process of the model.
–
The robustness of statistical estimates can often be improved by staged estimations, but at the cost of more complex interpretation
•
Risk service vendors report the decomposition of risk differently
–
Many of the reporting procedures follow an algebraic rather than economic reasoning
–
Much of the ambiguity relates to how the covariance terms are allocated to the involved factors
•
When dealing with “incremental risk contributions by position” we will be either implicitly or explicitly dealing with the existence of the contra-asset
–
Only some of the possible definitions of the contra-asset have simple algebraic structures