Jeff Bohn

Jeff Bohn, State Street

Improving portfolio-risk assessment with latent-factor-based simulation

Forward-looking, portfolio-risk models have become increasingly important for robust risk assessment and management of financial portfolios. Latent-factor models used with a forward-looking, Monte-Carlo simulation show promise for improving portfolio-risk assessment. In this paper, we show how a latent-factor model can facilitate an integrated, forward-looking risk assessment of a financial portfolio. Further, this bottom-up framework can disentangle contribution to large downside losses at a position, sub-portfolio and factor level. When embedded in a robust risk governance process that starts with a quantified risk-appetite statement, this framework makes it possible to more effectively identify sources of portfolio concentration/correlation risk. This analysis can lead to better identification of hedging strategies, better portfolio re-allocation strategies and more robust portfolio-risk management.