Sectorial Asset Allocation 2006-2012

We provide a methodology for credit risk analysis that can be embedded into a risk appetite framework. We start by estimating a global risk factor using CDS data, and we analyze the information content in a wide set of financial indicators on the global risk factor as well as on credit risk at the level of sectors. The global risk factor is then used to evaluate the systemic and idiosyncratic components of credit risk for sectorial credit indices. A similar decomposition of credit risk is obtained for CDS issuers in the industrial and financial sectors of Europe and North America. Such decomposition can be an important tool when evaluating the diversification possibilities of credit portfolios as well as for the design of appropriate hedging strategies. It could be used by financial institutions to maintain their risk limits when taking their asset allocation decisions as well as by supervisors searching for potential systemic risk problems