Risk Assessment and Capital Allocation

Sergio Scandizzo

Few things have failed so spectacularly during the 2007–09 financial crisis as the assessment of risks and the related prudential system of capital requirements. The former has shown theoretical and practical limitations in some of its most critical applications, such as the assessment of the likelihood of very severe events. The latter has failed to prevent some of the largest financial institutions from having to seek a public bailout in order to survive. As a consequence, both practices have gone through a period of substantial revisions in the wake of the 2007–09 crisis in the direction of increased resilience, higher prudence and reduced reliance on quantitative techniques. At the time of writing, however, there was still no consensus on the global regulatory reforms, nor had a completely new approach to risk measurement emerged. In the following pages and chapters, therefore, we will cover the topic of risk measurement by surveying what is still in place, and will be for the foreseeable future (the Basel II approaches to operational risk measurement and their quantitative and qualitative aspects), as well as what will certainly play an ever-increasing role in the future