Journal of Risk

Risk.net

Estimating economic capital allocations for market and credit risk

Paul Kupiec

ABSTRACT

Value-at-Risk (VAR) measures often are used as a basis for setting so-called “economic capital” or buffer stock measures of equity capitalization requirements. VAR measures do not account for the time value of money or the equilibrium required return premium for credit risk on a firm’s funding debt, and consequently they produce biased estimates of economic capital. The bias in common VAR approaches increases with the horizon and consequently is most pronounced in the credit risk setting where capital allocations horizons typically coincide with extended holding periods, but the bias is also important in the market risk setting when capital allocations are set for similar tenors. Accurate capital estimates can be obtained using a VAR-like measure that is constructed relative to a portfolio’s initial market value and augmented by an estimate of the interest compensation required on funding debt.

Sorry, our subscription options are not loading right now

Please try again later. Get in touch with our customer services team if this issue persists.

New to Risk.net? View our subscription options

If you already have an account, please sign in here.

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here: