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ERM Frameworks and Responses to risk [76]

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Bullet points include: Suppose L(R) is maximum allowable holding of an issuer (as % of portfolio) carrying a rating of R. Contribution to variance, C, if invest z in issuer’s paper, using a fraction k of the limit (dependent on the strength of our conviction, which we assume is independent of R) For reasonably rated paper, p should be reasonably small, so (1-p) should be close to 1 and C then simplifies to: Most appropriate choice of limit structure is indifferent between ratings for the same level of conviction regarding return outcomes, i.e. has C the same for each rating category. If the recovery rate is the same, then this implies that L should be inversely proportional to p.

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