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The Case for Fully Integrated Models of Economic Capital
Year Of Publication: 2009
Month Of Publication: February
Pages: 28
Download Count: 191
View Count:
Comment Num: 0
Language: EN
Source:
Who Can Read: Free
Date: 2-16-2009
Publisher: Administrator
Summary
Economic capital models are potentially powerful tools for enterprise risk manage-ment (ERM), and for the supervisory review process (Pillar 2) of the Basel II andSolvency II regulatory capital frameworks. We argue that, to ful ll this potential,economic capital models need to be fully integrated and to go beyond the more mod-ular approaches that dominate Pillar 1 methodology. In a modular approach capitalis determined at business-unit or risk category level (e.g. market, credit and liquidityrisk separately) and aggregated ex post by simple summation or correlation-adjustedsummation; in a fully integrated approach aggregation occurs implicitly by relatingall risks to a common set of fundamental risk drivers.We explain how calibrated economic scenario generation lies at the heart of afully integrated approach to modelling the risks on the asset side of a rm's balancesheet and discuss how stochastic scenario generation gives the ideal framework forexploring the diversi cation bene ts that di erent units or asset classes bring to anenterprise. We explain how this approach allows us to understand the sources of tailrisk and gives us a platform for integrated stress testing, sensitivity analysis, and theallocation of capital to business units for risk-adjusted performance comparisons.
Author(s)
McNeil, Alexander Sign in to follow this author
Kretzschmar, Gavin Sign in to follow this author
Kirchner, Axel Sign in to follow this author
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