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FRM Part II · FRM Exam Part II · Integrated Risk Management

A bank's risk team computes stand-alone economic capital of 60 for credit risk, 40 for market risk and 20 for operational risk. When aggregating, the team simply adds the three figures to get 120. Which statement best describes the implicit assumption and the likely effect of this approach?

Adding stand-alone capital figures implicitly assumes perfect positive dependence between the risk types, so no diversification is recognized. Because real dependence is imperfect, this building-block sum typically overstates total required capital compared with methods that model correlation or copulas.

  1. AIt assumes perfect positive dependence between risk types and typically overstates total capital relative to approaches recognizing diversificationCorrect
  2. BIt assumes zero correlation between risk types and typically understates total capital
  3. CIt assumes negative correlation between risk types and typically understates total capital
  4. DIt assumes independence and gives the same result as a copula-based aggregation

Explanation

Simple summation of stand-alone capital is equivalent to assuming perfect correlation (correlation of 1) across risk types. Any imperfect dependence yields diversification benefit, so the sum is conservative and overstates the aggregate. Assuming zero correlation would give a lower figure, not the sum.

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