In today’s environment more than ever, risk attribution is
becoming critical to understanding portfolio composition. It is
more important to understand how much risk we are effectively
betting on a given position as it is to create a prediction for
the return of that position. Incorrect position sizes (look up
the London Whale) can turn a positive expectation into a
negative proposition at the portfolio level. But how do we
determine risk in a portfolio context? The traditional method of
decomposing risk looks at both marginal and risk contributions
for the assets contained in the portfolio. First, lets define
what marginal contributions are in contrast to risk
contributions. The concept of marginal is central to economics,
and considers the unique impact of a change in a variable in the
context of a complex system. It is essentially a derivative that
measures the rate of change in some measure of interest given a
small change in a variable. An example might be studying what if
any impact further quantitative