Horizon of Economic Capital for market risk

[george.bilkis]

What is the common practice in terms of horizon when setting Economic Capital for market risk?
Is it 10 business days as regulatory VaR?

Thanks,
G

 

[ShaktiRathore]

Hello there,
Under the basel approach, IMA method the common horizon is 1 year(250 business days) at 99% CL. The economic capital is usually calculated using the 1 yr horizon unlike the regulatory VaR.

thanks

 

[george.bilkis]

I am not sure I understand how this works.
Lets assume I am a financial institution with rolling daily portfolio of 1 million USD
Daily mean is 0.00012 (30% annual) and stdev is 0.02 (equivalent to 31.62%), lets assume that returns are normally distributed.
1-day-VaR 99%: -(0.00012-2.32634*0.02)*$1 million = $45,327

Regulatory Capital that I have to hold aside this position is roughly: 3*sqrt(10)*1dayVaR(99%)
3*sqrt(10)*1dayVaR(99%) = 3* $143,336 = $393,959

Economic capital calculation:Confidence level of AA rating: 99.95%
Critical value (0.005) = -2.5758
1-year-VaR direct calculation: -(0.3-2.5758*0.3162)*$1million=$1,114,549

So, I have a portfolio $1 million, day after day it does not change. And at the end of the year, on the Asset side, I still have 1 million (+ may be some change).
Against this asset I have to put aside as a capital more than I invested ?
If that was so, we would not see a lot of business go around.

What am I missing?
G

 

[george.bilkis]

Ahh,
That was a calculation mistake.
1 year Economic Capital (direct calculation) at 99.95 is of course $514,549. That makes sense in a way that it is somehow comparable to regulatory charge.

On the other hand, Deutsche Bank calculates EC at 1 year horizon at 99.98% confidence level
https://annualreport.deutsche-bank....rt/riskreport/marketrisk/economiccapital.html

At these levels EC would be: $819,473. More than twice from regulatory capital.
That surprises me.

Thanks for the answer, ShaktiRathore.

G