With the Basel II and Solvency II framework in place, all types of financial intermediaries are preparing to implement economic capital measurement at some level of granularity.
This new addition to the Risk Books Introductory Series identifies the basic building blocks for economic capital measurement. It familiarises and trains a newcomer to the economic capital building blocks, computation approaches and taxonomy, risk measures, risk aggregation, distribution, correlation and dependency structures, risk mitigation, simulation and basic modelling techniques necessary for an institution to invent their own techniques and parameters for modelling economic capital for various types of risks.
The primer format will enable new entrants to quickly grasp the fundamental concepts, and covers:
• Economic capital: the purpose and objectives • Credit risk • Insurance risk • Market risk • Operational risk • Liquidity risk • Correlations and approximations
Recommended for risk managers, compliance officers, information technology planners and implementers, front and middle office personnel and students of Financial Engineering and Financial Risk Management courses.
TABLE OF CONTENTS
1. Economic Capital Economic capital distribution Regulatory capital versus economic capital Economic capital aggregation Issues of model risk Conclusion
2. Credit Risk Revisiting the Basel II model Challenges and approximations of the Basel II model Extending the Basel II model Extending the Basel II model for sector concentration Stochastic process Markovian process Building transition matixes Regime shifting Dependency structures Copulas Credit spreads Unbundling the shape of a credit spread curve Modelling correlation Counterparty risk Building the counterparty exposure profile Conclusion
3. Insurance Risk Insurance risks Solvency II Internal models Conclusion
4. Market Risk Stylised facts about market risk Pricing, returns and risk premiums Common characteristics of financial time series Risk premiums A common approach to derive EWMA, ARMA, ARCH and GARCH Stochastic volatility models Challenge of EWMA, ARMA, ARCH and GARCH models Volatility Value-at-risk Recommended best practices for VaR models Evaluation VaR models Conclusion
5. Operational Risk Overview of advanced measurement approach Issues and challenges concerning loss data Extreme-value theory Modelling insurance Conclusion