Determining and Allocating Diversification Benefits for a Portfolio of Risks

A critical problem in financial and insurance risk analysis is the calculation of risk margins. When there are a number of risks, the total risk margin is often reduced to reflect diversification. How large should the "diversification benefit" be? And how should the benefit be allocated to to the individual risks? We propose a simple statistical solution. While providing a theoretical analysis, the final expressions are readily implemented in practice.

Keywords: Diversification, Allocated risk margins, Stand-alone risk margins, Capital allocation, Euler allocation, Percentile risk aversion.