Skip to content

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

A bank uses incremental (with-and-without) capital to evaluate business units. The risk manager notes that the incremental capital figures for all units, summed together, do not equal total bank economic capital. What is the most likely reason and implication?

Incremental capital is not additive. Each unit's figure is the change in total capital when that unit is removed, so the sum generally falls short of total bank capital. The residual must be allocated by a separate rule, which is a known implementation limitation of the with-and-without approach.

  1. AIncremental capital is not additive, because each figure measures a unit removed from the whole portfolio, so a residual must be allocated separatelyCorrect
  2. BIncremental capital is always additive when computed at the same confidence level
  3. CIncremental capital double counts diversification, so the sum always exceeds total capital
  4. DThe sum differs only because of different time horizons across units

Explanation

Incremental capital measures the change in total capital when a unit is removed, capturing its full diversification benefit each time. For a typical portfolio the sum of these differs from total capital (usually falls short), leaving a residual that needs an allocation rule. Option C has the direction wrong, since the sum typically falls short rather than exceeds.

Did you get it right without looking?

One question tells you little. A timed set on Risk Capital Attribution and Risk-Adjusted Performance Measurement shows your real accuracy, how long you take and where you lose marks.

Practise Risk Capital Attribution and Risk-Adjusted Performance MeasurementFree diagnostic mock

More Risk Capital Attribution and Risk-Adjusted Performance Measurement questions