Risk budgeting is a process by which financial organizations and investment managers determine where risks should be taken and how the risks can be most effectively allocated across the organization. It establishes objectives for specific individuals and groups as well as the entire organization. Then the limits are carefully measured, monitored and managed.
Risk budgeting allows profits for different business units to be compared in proportion to the amount of capital that they employed and the risks they took to achieve the profits. In organizations that hire outside investment managers, risk budgeting can help them allocate funds among the various managers.
Since certain risks tend to offset each other (offering diversification) the total risk budget for a firm will typically exceed the sum of the risk budgets assigned to individual business units.For more information, see all articles on: Asset Allocation, Risk Management See also: