FRM Part II · FRM Exam Part II · Credit Risk
A credit portfolio has an expected loss of USD 12 million and a 99.9% one-year credit VaR (loss quantile) of USD 95 million. A risk manager wants to state the economic capital for credit risk, assuming expected losses are covered by pricing and provisions. What is the economic capital?
Economic capital is the loss quantile minus expected loss, because expected loss is covered by pricing and provisions. That gives USD 95 million minus USD 12 million, or USD 83 million. Using the full quantile or adding expected loss misstates the unexpected loss buffer.
- AUSD 12 million
- BUSD 83 millionCorrect
- CUSD 95 million
- DUSD 107 million
Explanation
Economic capital covers unexpected loss: quantile loss minus expected loss = 95 - 12 = 83 million. USD 95 million ignores that EL is already provisioned. USD 107 million adds EL with the wrong sign.
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