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Portfolio risk allocation through Shapley value

Patrick S. Hagan, Andrew Lesniewski, Georgios E. Skoufis and Diana E. Woodward

Papers from arXiv.org

Abstract: We argue that using the Shapley value of cooperative game theory as the scheme for risk allocation among non-orthogonal risk factors is a natural way of interpreting the contribution made by each of such factors to overall portfolio risk. We discuss a Shapley value scheme for allocating risk to non-orthogonal greeks in a portfolio of derivatives. Such a situation arises, for example, when using a stochastic volatility model to capture option volatility smile. We also show that Shapley value allows for a natural method of interpreting components of enterprise risk measures such as VaR and ES. For all applications discussed, we derive explicit formulas and / or numerical algorithms to calculate the allocations.

Date: 2021-03
New Economics Papers: this item is included in nep-cwa, nep-fmk, nep-gth and nep-rmg
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