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214 RISK MANAGEMENT AND VALUE CREATION IN FINANCIAL INSTITUTIONS
Consistent Application of the Measurement Framework In order to make the
risk measurement across the three types of risk compatible, we must apply
the framework for determining economic capital consistently. We will briefly
discuss three areas that are especially important in this respect.
Consistent choice of the measurement period: As indicated in the discussion
of the derivation of the economic capital for each of the three
types of risk, the measurement period over which this forward-looking
total risk measure is applied should be consistent across these three types
of risks. However, in general, the economically relevant distribution of
(gains and) losses is the one that corresponds to (gains and) losses the
bank can do nothing about after having itself committed to a portfolio
of financial assets, that is, the time horizon throughout which the bank
has no control over the distribution. 380
This differentiated holding period perspective—which is the relevant
perspective from a management intervention point of view—has little to
do with the gains and losses when we view them from a value-creation
perspective. There are various reasons 381 why this is the case and why
a consistent one-year horizon for risk quantification makes sense:
■ We use the external rating agencies’ estimation of the one-year default
probability as the anchor point of our calibration of the confidence
level (this point is discussed later). Therefore, we need to use
a consistent distribution across risk types to make sensible use of
this external benchmark.
■ Since value creation should be always linked to pecuniary incentives
for the employees 382 and the review cycle for employees is typically
on an annual basis, we should choose the same (consistent) time
horizon to evaluate the performance and riskiness.
■ Likewise, the typical review cycle for a credit customer is on an annual
basis—upon the presentation of the annual financial statement.
■ Because of the lack of data for observing the (economic) value changes
of the positions in the portfolio (this is especially the case for illiquid
credits and operational risk), we need to use the profit and loss (P&L)
statement as a fallback proxy of the economic returns. 383 Even though
many companies and banks have switched their reporting cycle to
380 See Stulz (2000), p. 4-14.
381 Culp and Miller (1998), p. 28, provide a list of other determinants for choosing
a consistent time horizon: key decision-making events, major reporting events, regulatory
examinations, tax assessments, external quality assessments, and so on.
382 See, for example, Stewart (1991), p. 225.
383 For a different opinion see Kimball (1998), p. 44, footnote 13.