Question 26.6: Suppose that the economic capital estimates for two business...

Risk Management and Financial Institutions

Suppose that the economic capital estimates for two business units are as follows:

Business Units
2	1
40	20	Market Risk
30	40	Credit Risk
10	70	Operational Risk

The correlations are as in Table 26.3. Calculate the total economic capital for each business unit and the two business units together.

Table 26.3 Correlations between Losses in Example 26.3
OR-2	CR-2	MR-2	OR-1	CR-1	MR-1
0	0	0.4	0.2	0.5	1	MR-1
0	0.6	0	0.2	1	0.5	CR-1
0	0	0	1	0.2	0.2	OR-1
0.2	0.5	1	0	0	0.4	MR-2
0.2	1	0.5	0	0.6	0	CR-2
1	0.2	0.2	0	0	0	OR-2

The blue check mark means that this solution has been answered and checked by an expert. This guarantees that the final answer is accurate.
Learn more on how we answer questions.

Related Answered Questions

Question: 26.7

In Problem 26.6, what is the incremental effect of each business unit on the total economic capital? Use this to allocate economic capital to business units. What is the impact on the economic capital of each business unit increasing by 0.5%? Show that your results are consistent with Euler’s ...

Verified Answer:

The incremental effect of Business Unit 1 on total...

Question: 26.8

A bank is considering expanding its asset management operations. The main risk is operational risk. It estimates the expected operational risk loss from the new venture in one year to be $2 million and the 99.97% VaR (arising from a small chance of an large investor lawsuit) to be $40 million. ...

Verified Answer:

The capital is $38 million and the return before t...

Question: 26.9

RAROC can be used in two different ways. What are they? ...

Verified Answer:

RAROC can be used to compare the past performance ...

Question: 26.5

Suppose that the credit loss in a year has a lognormal distribution. The logarithm of the loss is normal with mean 0.5 and standard deviation 4. What is the economic capital requirement if a confidence level of 99.97% is used? ...

Verified Answer:

The 99.97% worst-case value of the logarithm of th...

Question: 26.4

In what respects are the models used to calculate economic capital for market risk, credit risk, and operational risk likely to be different from those used to calculate regulatory capital? ...

Verified Answer:

The models used for economic capital are likely to...

Question: 26.3

What types of risk are included in business risk? ...

Verified Answer:

Business risk includes risks relating to strategic...

Question: 26.2

What determines the confidence level used by a AA-rated financial institution in its economic capital calculations? ...

Verified Answer:

The probability of a AA-rated company defaulting i...

Question: 26.1

What is the difference between economic capital and regulatory capital? ...

Verified Answer:

Economic capital is a bank’s own estimate of the c...