M-SD3 Model: A Multi-Dimensional Risk Decomposition

Abstract

In this paper we propose a new risk decomposition technique. Taking an example of a portfolio of assets that can be decomposed into sub portfolios and also represented using a factor model, investment professionals have access to tools that can represent risk from three different perspectives using standard techniques of risk decomposition: (a) assets, (b) sub portfolios and (c) factors. The SD3 model, which we are going to describe in this paper, aims to decompose the risk of the portfolio using 2 or 3 dimensions simultaneously, thereby providing a tool for a more comprehensive view and understanding of the risk drivers for a portfolio.