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Granularity Shock: A Small Perturbation Two-Factor Model

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  • Osadchiy, Maksim

Abstract

The paper presents a small perturbation two-factor model designed to capture granularity risk, extending the Vasicek Asymptotic Single Risk Factor (ASRF) portfolio loss model. By applying the Lyapunov Central Limit Theorem, we demonstrate that, for small values of the Herfindahl-Hirschman Index (HHI), granularity risk, conditional on market risk, is proportional to a standard normal random variable. Instead of studying the behavior of a heterogeneous portfolio, we examine the behavior of a homogeneous portfolio subjected to a small perturbation induced by granularity risk. We introduce the Vasicek-Herfindahl portfolio loss distribution, which extends the Vasicek portfolio loss distribution for heterogeneous portfolios with low HHI values. Utilizing the Vasicek-Herfindahl distribution, we derive closed-form granularity adjustments for the probability density function and cumulative distribution function of portfolio loss, as well as for Value at Risk (VaR) and Expected Shortfall (ES). We compare the primary results of our approach with established findings and validate them through Monte Carlo simulations.

Suggested Citation

  • Osadchiy, Maksim, 2025. "Granularity Shock: A Small Perturbation Two-Factor Model," MPRA Paper 124190, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:124190
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    More about this item

    Keywords

    Credit portfolio model; Granularity adjustment; Value at Risk; Expected Shortfall;
    All these keywords.

    JEL classification:

    • C46 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Specific Distributions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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