Figure 1 shows the results. In the figure the x-axis represents the size of the new portfolio relative to the existing portfolio. At a level of 1, the new and existing portfolios have equal size. We can see in the chart that for the first $10 billion investment (or 10% of the original portfolio size), the standard deviation increase is just over 2% of the asset increase. As the size of the second portfolio reaches $100 billion the incremental standard deviation is just over 4%. As the size of the second portfolio is significantly greater than the first portfolio, the incremental risk approaches the asset standard deviation of 5%. Thus as a firm increases the size of a new asset class relative to its existing business, that asset class should face an increasing capital requirement. Likewise it might be appropriate to place a higher capital requirement on GSE portfolios as they represent a larger segment of the market.

Figure 1

 

 

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