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Justification Of Per-Unit Risk Capital Allocation In Portfolio Credit Risk Models

Author

Listed:
  • GREGOR DORFLEITNER

    (Department of Finance, University of Regensburg, Universitätsstr. 31, 93040 Regensburg, Germany)

  • TAMARA PFISTER

    (Department of Finance, University of Regensburg, Universitätsstr. 31, 93040 Regensburg, Germany)

Abstract

Risk capital allocation is based on the assumption that the risk of a homogeneous portfolio is scaled up and down with the portfolio size. In this article we show that this assumption is true for large portfolios, but has to be revised for small ones. On basis of numerical examples we calculate the minimum portfolio size that is necessary to limit the error of gradient risk capital allocation and the resulting error in a portfolio optimization algorithm or pricing strategy. We show the dependency of this minimum portfolio size on different parameters like the probability of default and on the credit risk model that is used.

Suggested Citation

  • Gregor Dorfleitner & Tamara Pfister, 2014. "Justification Of Per-Unit Risk Capital Allocation In Portfolio Credit Risk Models," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 17(06), pages 1-29.
    • Handle: RePEc:wsi:ijtafx:v:17:y:2014:i:06:n:s0219024914500393
    DOI: 10.1142/S0219024914500393
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    Cited by:

    1. Gregor Dorfleitner & Lars Hornuf & Martina Weber, 2018. "Paralyzed by Shock: The Portfolio Formation Behavior of Peer-to-Business Lending Investors," CESifo Working Paper Series 7092, CESifo.

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