Why map portfolios to risk factors? It's a shortcut because portfolios are complicated; e.g., even delta-normal VaR employing a covariance matrix contains n(n+1)/2 pair-wise correlations in a dreaded "curse of dimensionality." The reality of a portfolio's true risk exposure is both ultimately unknowable and undeniably complex. Mapping reduces the portfolio to a few key characteristics. The approximation sacrifices accuracy but makes the portfolio amenable to, say, stress testing.
I like your lessons, really great for beginners but I think you should number them from Lesson 1 to Lesson N.
kingdavid3 2 years ago 2