Decomposing Dynamic Risks into Risk Components

Katja Schilling (), Daniel Bauer (), Marcus C. Christiansen () and Alexander Kling ()
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Katja Schilling: Institut für Versicherungswissenschaften, Universität Ulm, 89081 Ulm, Germany
Daniel Bauer: Department of Risk and Insurance, University of Wisconsin–Madison, Madison, Wisconsin 53706
Marcus C. Christiansen: Department of Risk and Insurance, University of Wisconsin–Madison, Madison, Wisconsin 53706
Alexander Kling: Institut für Finanz- und Aktuarwissenschaften, 89081 Ulm, Germany

Management Science, 2020, vol. 66, issue 12, 5738-5756

Abstract: The decomposition of dynamic risks a company faces into components associated with various sources of risk, such as financial risks, aggregate economic risks, or industry-specific risk drivers, is of significant relevance in view of risk management and product design, particularly in (life) insurance. Nevertheless, although several decomposition approaches have been proposed, no systematic analysis is available. This paper closes this gap in literature by introducing properties for meaningful risk decompositions and demonstrating that proposed approaches violate at least one of these properties. As an alternative, we propose a novel martingale representation theorem ( MRT ) decomposition that relies on martingale representation and show that it satisfies all of the properties. We discuss its calculation and present detailed examples illustrating its applicability.

Date: 2020
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Citations: View citations in EconPapers (5)

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