Economic Capital
First published:
ISBN: 9781904339366XY
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Economic Capital for Counterparty Credit Risk
Evan Picoult and David Lamb
Introduction
Background on Economic Capital
Volatility and Capital: Measures of Risk
Conceptual Framework for Economic Capital Models and Required Inputs
Recovery Risk and Economic Capital
The Significance of Economic Capital to Financial Institutions
Economic Capital for Retail Credit Card Portfolios
Economic Capital for Counterparty Credit Risk
Economic Capital for Securitisations
Economic Capital for Market Risk
Measuring and Calculating Economic Operational Risk Capital
A Fundamental Look at Economic Capital and Risk-Based Profitability Measures
A Risk-Factor Model Foundation for Ratings-Based Bank Capital Rules
Allocating Portfolio Economic Capital to Sub-Portfolios
Spectral Capital Allocation
Evaluating Design Choices in Economic Capital Modelling: A Loss Function Approach
COUNTERPARTY CREDIT EXPOSURE
Economic capital (EC) is a measurement of economic risk from an insolvency perspective. The measurement of EC for counterparty credit risk is conceptually more difficult than it is for a loan portfolio for three reasons: (a) the uncertainty in the future credit exposure, (b) the bilateral nature of counterparty credit exposure (ie, each party to a forward or swap has potential credit exposure to the other) and (c) the challenge of defining the credit value adjustment (CVA) to take into account the effect of market spreads on the market value of a derivative portfolio with a counterparty.
This chapter has five sections: (1) an introduction to issues surrounding the measurement of counterparty exposure and counterparty risk; (2) a description of the method for measuring a counterparty’s credit exposure profile on a portfolio basis; (3) a summary of the fundamental issues for measuring EC for a loan portfolio from a potential default-only and a potential loss-of-economic-value perspective; (4) a description of the method for measuring EC for counterparty risk from a potential default-only perspective; (5) a description of the method for measuring EC for
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