credit, operational and market/alm risk

[[email protected]]

Hi David,

First, I'd like to say thank you soooooooo much for your time and effort on answering our questions! Really really appreciate your help!

I have a question asking how to rank the amount of risk capital allocated to credit, operational and market risks. I have no clue about this and this seems not in any AIM?

Thank you for any help again!

 

[David Harper CFA FRM]

Sure thing, glad to help is why we are here!

I am not aware of any robust ranking principle in the absence of specifics. It typically shakes out that credit is highest ... but the point of economic (and, to a degree, regulatory capital) is to give a "common currency" such that any ranking is an ex post realization based on specifically analyzing each component.

sometimes a question like that is asking you to standardize the confidence % and time horizon because, if you take Basel (eg), the credit and oprisk are 99.9% one-year quantiles but the market risk is 99% ten-day, so i do recall questions asking you to covert different confidence/horizons the same and ranking that way.

But i can see how a generic ranking is useful. I would say, rather, that asking a generic ranking question is to miss a lot of key points about what risk capital means.

But feel free to post the actual question!!

Hope that helps, David

 

[[email protected]]

I see. I got your point.
Here is the actual question: (It is an actual exam question but I am not sure which year it is. )

Large banks typically allocate risk capital for credit, operational and market/ALM risks. Which of the following statements ranks the typical amount of risk capital allocated to these different risks correctly starting with the largest amount?
A. Market/ALM risk requires more risk capital than credit risk
B. Credit require more risk capital than market which requires more than operational
C. Market risk requires more than operational but less than credit
D. Credit risk requires more than operational which requires more than market
D is the answer.

More comments? Thanks!

 

[David Harper CFA FRM]

Hi ldcn,

It illustrates the weakness in using stale questions: a current candidate would rightly find "insufficient information to answer."
It refers to the empirical findings of a paper last in the FRM, i think in 2008 (I can tell b/c of the "ALM" attached to market).
This paper isn't assigned and, imo, questions like this are currently counter-productive. It's more useful to meditate on why it's impossible to answer this question
e.g., if we are using VaR approach (like in Basel), it may be a 10-day 99% market VaR versus a one-year 99.9% credit VaR

also notice the question does not explicitly state "economic capital" but rather "risk capital" (we might infer regulatory?)
... a current candidate should be aware that "risk capital" is not specific

Thanks, David

P.S. Append: I was curious, so i found the paper. Attached, according to my files this was assigned in 2008 FRM

 

[[email protected]]

Got it. Thanks.