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Estimating Credit Risk Capital What's the Use

Estimating Credit Risk Capital What's the Use Risk capital is an important input for management functions. Capital structure decisions, capital budgeting, and ex post performance measurement require different measures of risk capital. While it has become common to estimate risk capital using VaR models, it is not clear that VaRbased capital estimates are optimal for applications to management functions e.g. risk management, capital budgeting, performance measurement, or regulation. This article considers three typical problems that require an estimate of credit risk capital an optimal equity capital allocation an optimal capital allocation for capital budgeting decisions and an optimal capital allocation to remove moral hazard incentives from a compensation contract based on ex post performance. The optimal credit risk capital allocation is different for each problem and is never consistent with a credit VaR estimate of unexpected loss. The results demonstrate that the optimal risk capital allocation depends on the objective. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Risk Finance Emerald Publishing

Estimating Credit Risk Capital What's the Use

The Journal of Risk Finance , Volume 2 (3): 18 – Feb 1, 2001

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
1526-5943
DOI
10.1108/eb043465
Publisher site
See Article on Publisher Site

Abstract

Risk capital is an important input for management functions. Capital structure decisions, capital budgeting, and ex post performance measurement require different measures of risk capital. While it has become common to estimate risk capital using VaR models, it is not clear that VaRbased capital estimates are optimal for applications to management functions e.g. risk management, capital budgeting, performance measurement, or regulation. This article considers three typical problems that require an estimate of credit risk capital an optimal equity capital allocation an optimal capital allocation for capital budgeting decisions and an optimal capital allocation to remove moral hazard incentives from a compensation contract based on ex post performance. The optimal credit risk capital allocation is different for each problem and is never consistent with a credit VaR estimate of unexpected loss. The results demonstrate that the optimal risk capital allocation depends on the objective.

Journal

The Journal of Risk FinanceEmerald Publishing

Published: Feb 1, 2001

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