Implementation and Uses of Economic Capital ... - ERM Symposium

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How to determine the stressed conditions for each key risk driver? For each risk define the level of stress at the appropriate level of granularity E.g. Credit risk for at individual rating by asset class level (AAA Credit card ABS). Possibly differentiate based on underlying collateral features/vintages (2006 vs. 2004) Historical data based techniques to define stress level • Parametric approaches (e.g. ‘Best fit’ distributions) • Interpolation techniques Expert judgment & analysis based if historical data availability is limited Key points to consider when defining stress levels for any risk: • Non-normality and rich set of fatter tail distributions • Non linearity of dynamic functions (e.g. client behavior) • Second order risks (e.g. convexity) and cross-greek effects • Robust basis for judgments where “missing or lack” historical data • Relevant historical time frame (e.g. regime changes) • Relative vs. Absolute changes
Example of Stressing Key Risks: Equity level and volatility Equity level stress Specific level shocks by equity index (S&P 500, EAFE, Russell) e.g. S&P 500: 30+% stress over 1 year Time period: Balance between relevant regime and statistically significant data points Distribution of results: Lognormal Equity volatility stress Extremely high degree of correlation between equity level stress and elevated equity volatility •‘Stressed’ volatility is elevated volatility after 1 year equity level shock, not instantaneous short lived volatility peak Implied vs. historical realized volatility Full term structure of volatility (30 day to 10/15 year) Full Volatility surface (impractical for now) Build methodology to stress volatility despite very limited historical data on few points of the curve. frequency 60 50 40 30 20 10 0 S&P 500 annual log returns Compared to the lognormal distribution historical data (1950-2007) lognormal distribution LTCM, Russian default (1998) log returns VIX (S&P500 options) Dot-com bubble
Page 1 and 2: Use of Economic Capital for Perform
Page 3 and 4: Definition of Economic Capital (“
Page 5 and 6: Economic Capital is a more complete
Page 7 and 8: EC/ERM requires continually improvi
Page 9 and 10: The Executive Board defines Risk Ap
Page 11 and 12: Risk Dashboard provides an overview
Page 13 and 14: Example of EC approach within the R
Page 15 and 16: Concluding Remarks • ING has been
Page 17 and 18: Key technical elements of the EC me
Page 19 and 20: The rationale behind using a stress
Page 21: The key risks that financial servic
Page 25 and 26: Aggregating results across risks fo
Page 27 and 28: Linkage of EC with capital manageme
Page 29 and 30: Evolution of usage for capital mana
Page 31 and 32: It should be noted that this presen
Page 33 and 34: ERM’s efforts “connect the dots
Page 35 and 36: Rating Agencies Four major rating a
Page 37 and 38: Source: Citigroup Global Markets,
Page 39 and 40: European Insurers Report Increasing
Page 41 and 42: Economic Capital at AIG By focusing
Page 43 and 44: CRO Forum Recommendations Re EC Tim
Page 45 and 46: Assessment of Financial Strength of
Page 47 and 48: Economic Capital - the Importance o
Page 49 and 50: $BN 101.68 GAAP Shareholders' Equit
Page 51 and 52: $BN 25.0 20.0 15.0 10.0 5.0 0.0 AIG

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