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

More documents

Recommendations

Info

Example of Stressing Key Risks: Interest rate levels A Company can use Principal Component Analysis (PCA) to derive their worst case yield curve movement One approach used to identify this worst case yield curve movement is to generate 10,000 real world yield curve movements using PCA and then calculate the resulting impact on the market value of assets and liabilities for all the 10,000 scenarios (e.g. nested simulation or estimation using key rate durations). Alternatively, a firm may choose to determine the targeted (99.x%) real world principle component stresses (3x2) and for each calculate required economic capital (REC) Illustrative • The aggregate interest rate REC = SQRT (MAX PC 1 2 + MAX PC2 2 + MAX PC3 2 ) PCA allows yield curve movements to be decomposed into their primary drivers • Principal Component 1: Yield curve shifts The most important movement is an upwards or downward shift in the whole yield curve This typically explains over 70% of all yield curve movements • Principal Component 2: Yield curve twist Represents twisting of the yield curve (Around the 1 year rate) This normally accounts for an additional 15-25% of the variance of the yield curve • Principal Component 3: Yield curve inflection, bending or tilt Additional principle components become less intuitive and explain less than 2% of movements
Aggregating results across risks for one business: The use of correlation matrices has been the dominant industry trend Correlation matrix • By pair of tail risk events (e.g. equity level and interest rate level) • In the tails, not average over time • Based on historical data and expert judgment (where data is limited) • Emerging as the best practice across the industry with increasing degree of convergence in the range of values across different users • Correlation at the lowest level of risk drivers (sub-components of risk) not just between major risk categories (like equity, interest rate, credit) • Test correlations by evaluating vs. specific scenarios with no assumed correlation Historical extreme events like 1987 market crash, Russian default 1998, 2001, 2008 Hypothetical scenarios like inflation spike, increased leverage in the system widening spreads Copula (a set of fitted correlation distributions) • A newer practice. May be challenged by lack of data to fit distributions • Can be difficult to explain results & business linkages to management
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 and 22: The key risks that financial servic
Page 23: Example of Stressing Key Risks: Equ
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

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

Create successful ePaper yourself

Delete template?

Save as template?