Market Risk Capital Definitions and Market Risk: Capital to do what?
Document ID: 2006-803 (previously 2006/006)
Published on: 31st July 2006
Author: Craig Turnbull
This research note discusses how VaR and run-off definitions of risk capital require different ‘types’ of market risk to be risk capitalised. Specifically, risky-asset return volatility can be considered to arise for two fundamental reasons: because asset cashflow expectations change; or because asset risk premia change. When some asset return volatility is assumed to arise because of variations in asset risk premia rather than changes in asset cashflow expectations, the run-off capital requirement can be expected to be less than the VaR capital requirement. This is because such sources of volatility must be risk capitalised under VaR, but make no contribution to risk capital under the run-off definition.
