Risk contribution
The share of the portfolio's volatility that comes from one holding.
Weight says how much you own; risk contribution says how much of the ride it is. A small position in something volatile and correlated with the rest can be a large share of the risk.
Formula
Contribution of i = wᵢ × (Σw)ᵢ ÷ σ²ₚ
Inputs
- wᵢ. The holding's weight.
- Σ. The annualized covariance matrix of daily returns.
- σₚ. The portfolio's volatility.
How to read it
The contributions add up to 100%. Effective bets = 1 ÷ Σ(share²) counts how many independent sources of risk there really are.
How to use it
Find the holding whose risk is out of proportion to its weight — the usual first thing to trim when de-risking.
Limitations
From the days every holding shares; the covariance of a few dozen names is itself noisy.
Also called: risk contribution, effective bets.