Portfolio Volatility Contributions of Risk Factors in the Presence of Risk Factors Multi-collinearity

Andrea Mecchina (), Enrico Regolin, Nicola Torelli and Luca Bortolussi
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Andrea Mecchina: University of Trieste, Department of Mathematics, Informatics and Geosciences
Enrico Regolin: Generali Asset Management SGR S.p.A.
Nicola Torelli: University of Trieste, Department of Economics, Business, Mathematics and Statistics
Luca Bortolussi: University of Trieste, Department of Mathematics, Informatics and Geosciences

A chapter in Mathematical and Statistical Methods for Actuarial Sciences and Finance, 2024, pp 229-234 from Springer

Abstract: Abstract Attributing the volatility of a portfolio to some exogenous risk factors which are not directly invested in by the portfolio may be a topic of interest to asset managers. Without any restriction on the nature of risk factors, we must take into account that their returns may exhibit strong correlations. Risk factor returns multi-collinearity causes severe problems in estimating their portfolio volatility contributions. In order to solve this issue, we propose a risk attributing pipeline that applies an orthogonalisation algorithm to risk factor returns. Most importantly, the risk factors interpretability is preserved, in the sense that the orthogonalised risk factors are the ones attaining the least Frobenius norm of the matrix of deviations from the original risk factors.

Keywords: risk contributions; multi-collinearity; orthogonalisation; interpretability (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-3-031-64273-9_38

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DOI: 10.1007/978-3-031-64273-9_38

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