Which technique is a top-down approach?

Top-Down Approach

In simple terms, a top-down approach is an investment strategy that selects various sectors or industries and tries to achieve a balance in an investment portfolio. The top-down approach analyzes the risk by aggregating the impact of internal operational failures. It measures the variances in the economic variables that are not explained by the external macro-economic factors. As such, this approach is simple and not data-intensive. The top-down approach relies mainly on historical data. This approach is opposite to the bottom-up approach.

Bottom-Up Approach

A bottom-up approach, on the other hand, is an investment strategy that depends on the selection of individual stocks. It observes the performance and management of companies and not general economic trends. The bottom-up approach analyzes individual risk in the process by using mathematical models and is thus data-intensive. This method does not rely on historical data. It is a forward-looking approach unlike the top-down model, which is backward-looking.

[Related read:Risk Management Strategies]

Differences Between Top-Down Approach and Bottom-Up Approach

• The top-down approach analyzes risk by aggregating the impact of internal operational failures while the bottom-up approach analyzes the risks in an individual process using models.
• The top-down approach doesnt differentiate between high-frequency low severity and low-frequency high severity events while the bottom-up approach does.
• The top-down approach is simple and not data-intensive whereas the bottom-up approach is complex as well as very data-intensive.
• Top-down approaches are backward-looking while bottom-up approaches are forward-looking.

These are the basics of the top-down approach and the bottom-up approach.

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