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FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement

A bank allocates capital to a loan desk using expected-shortfall contributions at the 99% level, rather than allocating by notional exposure. What is the main advantage of the expected-shortfall contribution approach?

Expected-shortfall contributions show how much each desk contributes to portfolio losses in tail scenarios, capturing dependence and concentration, and they add up to the portfolio's total expected shortfall. Notional allocation ignores these risk features and stand-alone ES ignores diversification.

  1. AIt guarantees every desk a positive return on capital
  2. BIt reflects how much each desk contributes to portfolio losses in tail scenarios, and the contributions add up to total expected shortfallCorrect
  3. CIt removes the need to estimate correlations between desks
  4. DIt equals each desk's stand-alone expected shortfall

Explanation

Expected-shortfall contributions measure each desk's average loss in the scenarios where portfolio loss is in the tail, and they sum to total ES. Notional allocation ignores risk and diversification. The contributions still depend on dependence structure and differ from stand-alone ES.

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