Marking systemic portfolio risk with the Merton model
A technical paper outlining a generalisation of Merton’s option formula in helping quantify systemic risk to portfolios of assets.
The downside risk of a portfolio of assets is generally substantially higher than the downside risk of its components. In times of crisis, when assets tend to have high correlation, the understanding of this difference can be crucial in managing the systemic risk of a portfolio.
In this article, Alex Langnau and Daniel Cangemi generalise Merton’s option formula in the presence of jumps to the multi-asset case. The methodology provides a new way to mark and risk-manage the systemic risk of
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