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Concentration Ratio

Concentration risk is the risk of financial loss that may arise due to exposure to multiple counterparties for a specific group.

Concentration Risk and Concentration Ratio

Concentration risk is the risk of financial loss that may arise due to exposure to multiple counterparties for a specific group. The concentration ratio measures concentration risk. A lower (higher) concentration ratio shows that the creditor has more (less) diversified default risk.

Example of Concentration Risk and Concentration Ratio

For example, the concentration ratio for a creditor with 100 loans of equal size to different entities is 0.01 (= 1 / 100). If a creditor has one loan to one entity, the concentration ratio for the creditor is 1.0 (= 1 / 1).

Why are Concentration Risk and Concentration Ratio important?

The changes in the concentration ratio are directly related to changes in the default correlations. In the case of a decrease in the concentration ratio, a decrease in the default correlation can be observed. The default of companies A and B can be expressed as two binomial events with a value of 1 is default and 0 if not in default.

Owais Siddiqui
1 min read
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