Portfolio Risk Contribution ranks sources of a portfolio’s overall risk in the volatility of individual position holdings, helping you identify where risk is coming from. You may find some of the results surprising, especially when the portfolio includes riskier individual positions which are diversified (that is, they don’t tend to move together).
• Bars Show Risk Contribution of Position. Each bar reflects how much of the overall portfolio’s volatility comes from a specific holding, which is a function in part of the weight of that holding in the portfolio. Bars for all portfolio positions should sum to 100%, though the total may be subject to rounding errors.
There are some nuances. Please contact us for more technical information—bars are computed using not only the weight of the stock in the portfolio and the implied volatility of the stock, but also an adjustment based on the correlation of such stock with the rest of the portfolio. This essentially calculates a “marginal” risk contribution for changes in the Portfolio Risk when adding an additional unit of said stock. Because of the correlation adjustments, a negatively correlated position will have a negative bar height signifying negative Risk Contribution—reducing the weight of a negatively correlated position, in other words will raise Portfolio Risk, and adding the weight of a negatively correlated position will reduce Portfolio Risk. The portfolio’s overall risk may be lower than individual components thanks to the benefits of diversification, which is a powerful allocation strategy for reducing risk. Read more about the finance use of ‘diversification’ at Investopedia and Wikipedia.
• Dots Show Position Risk. The dots show how ‘stable’ or ‘jittery’ an individual holding is, as measured by the holding’s annualized implied volatility (which is itself determined from the market prices for options on the underlying holding). Dots, in contrast to bars, are not affected by a position’s weight in the portfolio.
• Horizontal Blue Line Shows Market Risk. We currently use the VIX as our measure of market risk, though this may be refined further in the future. The VIX, often called the ‘fear index’ or ‘fear gauge’, is roughly a reading of the implied volatility of the S&P 500 for the coming 30 days, as calculated from the price of publicly traded options on the S&P 500. You can think of this line as the ‘position risk’ of the S&P 500, to compare whether individual positions are reading as more or less volatile than the market as a whole. Read more about ‘implied volatility’ and the VIX at Wikipedia,Investopedia, and the Chicago Board Options Exchange. Read more about the S&P 500 at Wikipedia,Investopedia, and S&P Dow Jones Indices.