Risk Management and Value Creation in ... - Arabictrader.com

204 RISK MANAGEMENT AND VALUE CREATION IN FINANCIAL INSTITUTIONS
All events can be assumed to be independent of each other and of events
in other event risk categories. The probabilities of a fire, systems failure, or
fraud are, in the vast majority of cases, not related to each other. Therefore,
ρ ij
is assumed to be zero, and hence Equation (5.34) reduces to
UL
,
= ∑
2 2
w UL
ER P i i
i
(5.35)
Again, similar to credit risk, we can derive the required amount of
economic capital for event risk by assuming a shape of the portfolio distribution
of events. 337 We can determine the capital multiplier (CM) by estimating
the distance between the expected level of losses and the cut-off
point of the distribution, which is determined by the chosen confidence level,
expressed as a multiple of the standard deviation of losses, as shown in Figure
5.9.
Of course, and again similar to credit risk, these results can also be
achieved by more sophisticated Monte Carlo simulations.
EL ER,P
Confidence Level
UL ER,P = σ
Loss
Probability
Losses
Figure 5.9
Economic Capital
= UL ER,P x CM
Distribution for deriving economic capital for event risk.
0
337 Given that event risk is more similar to insurance risk than to credit risk, that is,
the distribution is even more skewed than for credit risk, assuming a beta distribution
here is less appropriate. Some authors, therefore, suggest using a Weibull distribution,
see, for example, Ong (1999), p. 201.