Determining and Allocating Diversification Benefits for a Portfolio of Risks

Abstract

A critical problem in fi nancial 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 refl ect diversifi cation. How large should the "diversifi cation benefi t" be? And how should the benefi t be allocated to the individual risks? We propose a simple statistical solution. While providing a theoretical analysis, the fi nal expressions are readily implemented in practice.