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FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks

A bank moves its economic capital confidence level from 99.90% to 99.99% without changing its models. Which consequence is most likely?

Economic capital rises when the confidence level moves from 99.90% to 99.99%, and the figure becomes more sensitive to tail and correlation assumptions because few data points exist that far out. Higher confidence therefore increases model uncertainty rather than reducing it.

  1. AEconomic capital rises, and the estimate becomes more sensitive to tail assumptions and limited dataCorrect
  2. BEconomic capital falls because default probabilities fall
  3. CEconomic capital is unchanged because expected loss is fixed
  4. DEstimation error falls because more of the distribution is covered

Explanation

A higher confidence level moves further into the tail, increasing the capital figure. Fewer observations inform the extreme tail, so results depend heavily on distributional and correlation assumptions, increasing model risk. Capital does not fall, and expected loss is unaffected by the level.

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