What is risk attribution?

The aim of risk attribution is to specify the contribution of each security to the overall risk of the portfolio. Simply summing the risk of each individual security will not equate the portfolio’s risk because it does not account for the role of correlation. Securities that are highly correlated with the portfolio are riskier than ones that are uncorrelated. In the former case, the security tends to co-move with the rest of the portfolio, thus offering little diversification. A negative correlation, by contrast, actually reduces risk, since it acts as a hedge for the rest of the portfolio.

We use a measure called Marginal Contribution to Total Risk (MCTR) for risk attribution. It basically says that a position's riskiness depends on three characteristics:

Characteristic	Riskier positions	Less risky positions
Allocation	Larger	Smaller
Individual volatility	Higher	Lower
Correlation to portfolio	High (co-moves with portfolio)	Low or negative (acts as a hedge)

The mathematical formulation is complex and involves finding the resulting change in portfolio risk from an incremental change in the allocation of a single security (with all others kept constant). A nice property of MCTR is that it adds to the total portfolio risk.

Our risk attribution widget performs the above calculations and represents the contribution to portfolio risk, using stacked bars. For more information on the risk attribution visualization, please refer to the help document.

Knowing the contributions to risk is important to help investors ascertain if there are some positions representing too much or too little risk.