Beruflich Dokumente
Kultur Dokumente
A.J.McNeil@hw.ac.uk www.ma.hw.ac.uk/mcneil
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1. Basel II, Solvency II & Economic Capital
1988. First Basel Accord takes first steps toward international
minimum capital standard. Approach fairly crude and insufficiently
differentiated.
1993. The birth of VaR. Seminal G-30 report addressing for first
time off-balance-sheet products (derivatives) in systematic way.
At same time JPMorgan introduces the Weatherstone 4.15 daily
market risk report, leading to emergence of RiskMetrics.
Rationale for the new accord: more flexibility and risk sensitivity
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Solvency II
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Economic Capital: What Is It?
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Economic Capital: How Far Have We Got?
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The 2006 IFRI/CRO Forum survey
17 banks taking part:
One of the major areas for further discussion within the industry
(currently in Basel II and shortly in Solvency II) - the treatment
of diversification effects - shows little sign of a single approach
holding sway. Estimates of the impact of diversification on the
capital estimate differ significantly driven by two main factors:
The approaches institutions use differ, for instance variance-
covariance matrices are most popular in banking, while
simulation approaches and copulas are more popular in
insurance
Correlation estimates used vary widely, to an extent that is
unlikely to be solely attributable to differences in business mix
[IFRI Foundation and CRO Forum, 2007]
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No Single Approach for Diversification II
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Mathematical Framework
Ideal goal:
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Diversification and Correlation
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Example of Attainable Correlations
1.0
0.5
rho
0.0
0.5
1.0
0 1 2 3 4 5
sigma
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Correlation Confusion
where the ij are the correlations between the risks. (for, example
[CEIOPS-06, 2006], page 98)
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What Principle Underlies This?
Suppose
the risks (L1, . . . , Ld) are jointly normal with zero mean and
correlations given by ij .
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Short Derivation of Aggregation Rule
v
u d d
uX X
sd(L) = t ij sd(Li)sd(Lj )
i=1 j=1
Now VaR(L) = sd(L) and VaR(Li) = sd(Li) where is
the -quantile of standard normal. This yields
v
u d d
uX X
VaR(L) = t ij VaR(Li)VaR(Lj )
i=1 j=1
v
u d d
uX X
SCR = t ij SCRiSCRj .
i=1 j=1
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Issues with this style of bottom-up
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How to Account for Tail Dependence?
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Is the sum of capital charges a bound for SCR?
d
X
SCR = SCRi
i=1
Fallacy:
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Superadditive Capital
Actually, it is possible to construct models for (L1, . . . , Ld) with
unusual dependence structures such that
d
X
VaR(L) > VaR(Li) = SCR
i=1
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Better Bottom-Up
Copulas are a better theoretical tool for combining the individual
capital charges. They avoid tricky consistency requirements
imposed by working with linear correlations.
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Advantages
For an internal solvency capital model, this would be the more
principles-based way to proceed.
SRC
DF = Pd
i=1 SRCi
ECi
DFi =
SRCi
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Issues
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Impact of Dependence on Credit Loss Distribution
0.12
dependent
0.10
0.08 independent
probability
0.06
0.04
0.02
0.0
0 10 20 30 40 50 60
Number of losses
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References
[IFRI Foundation and CRO Forum, 2007] IFRI Foundation and CRO
Forum (2007). Insights from the joint IFRI/CRO Forum survey
on Economic Capital practice and applications. KPMG Business
Advisory Services.
[Treasury and FSA, 2006] Treasury and FSA (2006). Solvency II: a
new framework for prudential regulation of insurance in the EU.
HM Treasury and FSA. Discussion paper.
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