Credit Portfolio Theory

Credit Portfolio Theory analyzes how a collection of loans or credit assets behaves as a whole, rather than focusing on individual borrowers. It helps lenders and investors understand the overall risk, considering that some borrowers may default while others do not. By diversifying across many borrowers, the theory shows how the total risk can be reduced—even if individual risks are high—through careful management and balancing. This approach assists in predicting potential losses and optimizing the mix of credit assets to achieve desired returns while controlling risk exposure.