In theory the potential for credit risk diversi cation for banks could be substantial. Portfolios are large enough that idiosyncratic risk is diversi ed away leaving exposure to systematic risk. The potential for portfolio diversi cation is driven broadly by two characteristics: the degree to which systematic risk factors are correlated with each other and the degree of dependence individual rms have to the di¤erent types of risk factors. We propose a model for exploring these dimensions of credit risk diversi cation: across industry sectors and across di¤erent countries or regions. We nd that full rm-level parameter heterogeneity matters a great deal for capturing di¤erences in simulated credit loss distributions. Imposing homogeneity results in overly skewed and fat-tailed loss distributions. These di¤erences become more pronounced in the presence of systematic risk factor shocks: increased parameter heterogeneity greatly reduces shock sensitivity. Allowing for regional parameter heterogeneity seems to better approximate the loss distributions generated by the fully heterogeneous model than allowing just for industry heterogeneity. The regional model also exhibits less shock sensitivity. Key Words: Risk management, default dependence, economic interlinkages, portfolio choice JEL Classi cations: C32, E17, G20 We would like to thank participants at the NBER Conference on Risk of Financial Institutions, October 2004, and our discussant Richard Cantor for helpful and insightful comments. We would also like to thank Yue Chen and Sam Hanson for their excellent research assistance. yCorresponding author. Any views expressed represent those of the author only and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System. zAny views expressed represent those of the author only and not necessarily those of Mercer Oliver Wyman.