Concentration of risk vs aggregation of risk

[Alastair_in_SA]

Hi there

In chapter 23 it states that the risks of using derivatives include:

• aggregation
• concentration

I probably should know this from earlier subjects, but what is the difference between these two?

Thank you
Alastair

 

[Edwin]

Hi there

In chapter 23 it states that the risks of using derivatives include:

• aggregation
• concentration

I probably should know this from earlier subjects, but what is the difference between these two?

Thank you
Alastair

Hi Alastair,

Concentration risk is just the risk of too much exposure to one counterparty (assuming no netting of transactions)

For aggregation risk I have no idea what Acted what aiming at but I think you can explain it as a subset of model risk, in this case just the risk that the correlation structure/dependence structure in your portfolio changes worse than you expected e.g

LTCM (see here);- http://www.acted.co.uk/forums/showthread.php?t=8501&highlight=aggregation

they modelled the long-term relationship between different gov bond markets and used VAR models when assessing risks of their portfolios, they didn't take into account changes in these relationships under extreme events - tail dependence. Thus during the Thailand currency crisis-that-led to the Asian crisis-that-spiked the Russian debacle-that-led to a 'flight to quality' in capital markets, they went down!

So in short I think they are trying to say aggregation risk is when you have a portfolio and then undervalue your "aggregate" risk which for portfolios occurs when you undervalue tail risk.