Skip to content

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

A bank's economic capital framework aggregates capital across credit, market and operational risk. A risk manager compares the simple sum of the stand-alone capital figures with the aggregate figure produced by a model that allows for correlations below one. Which statement best describes the difference between the two figures?

Simple summation of stand-alone capital assumes perfect dependence between risk types, so it recognises no diversification benefit and is the most conservative aggregation approach. Models with correlations below one give lower aggregate capital. Summation is not tied to independence, which would produce much lower totals.

  1. AThe simple sum is the most conservative approach because it implicitly assumes perfect dependence across risk typesCorrect
  2. BThe simple sum understates capital because it ignores tail dependence between risk types
  3. CThe simple sum equals the model figure whenever risk types are measured at the same confidence level
  4. DThe simple sum is only valid when risk types are statistically independent

Explanation

Adding stand-alone capital figures is equivalent to assuming perfect correlation across risk types, so no diversification benefit is recognised. This gives the highest aggregate figure among the usual approaches. Independence would give a smaller figure, so option D is wrong.

Did you get it right without looking?

One question tells you little. A timed set on Range of Practices and Issues in Economic Capital Frameworks shows your real accuracy, how long you take and where you lose marks.

Practise Range of Practices and Issues in Economic Capital FrameworksFree diagnostic mock

More Range of Practices and Issues in Economic Capital Frameworks questions