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Variance-Covariance Based Risk Allocation in Credit Portfolios: Analytical approximation

by Mikhail Voropaev of ING Bank

May 2009

Abstract: High precision analytical approximation is proposed for variance-covariance based risk allocation in a portfolio of risky assets. A general case of a single-period multi-factor Merton-type model with stochastic recovery is considered. The accuracy of the approximation as well as its speed are compared to and shown to be superior to those of Monte Carlo simulation.

Keywords: credit portfolio, capital allocation, economic capital.

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