FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement
A bank's business units each have a stand-alone economic capital figure, but the sum of these figures exceeds the bank-wide economic capital computed for the whole portfolio. Which statement best describes the reason, and the purpose of capital attribution in this case?
The sum of stand-alone capital exceeds bank-wide capital because of diversification across imperfectly correlated units. Capital attribution allocates the lower bank-wide total back to units so that the allocated amounts add up exactly to total economic capital.
- ADiversification across units lowers total capital, so stand-alone capital must be allocated down to units using a method that sums to the bank-wide figureCorrect
- BStand-alone capital always understates risk, so the bank-wide figure must be scaled up to equal the sum
- CThe difference arises because units use different confidence levels, which attribution eliminates by raising total capital
- DThe difference is an accounting error that should be removed by ignoring correlations between units
Explanation
Imperfect correlation among units produces a diversification benefit, so the sum of stand-alone capital exceeds total capital. Attribution methods allocate the total so contributions add up to bank-wide capital. Scaling up the total or ignoring correlations would defeat that purpose.
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