This new addition to the Risk Books Introductory Series identifies the basic building blocks for economic capital measurement. It familiarises and trains a newcomer to the economic capital building blocks, computation approaches and taxonomy, risk measures, risk aggregation, distribution, correlation and dependency structures, risk mitigation, simulation and basic modelling techniques necessary for an institution to invent their own techniques and parameters for modelling economic capital for various types of risks.

The primer format will enable new entrants to quickly grasp the fundamental concepts, and covers:

• Economic capital: the purpose and objectives
• Credit risk
• Insurance risk
• Market risk
• Operational risk
• Liquidity risk
• Correlations and approximations

Recommended for risk managers, compliance officers, information technology planners and implementers, front and middle office personnel and students of Financial Engineering and Financial Risk Management courses.

1. Economic Capital
Economic capital distribution
Regulatory capital versus economic capital
Economic capital aggregation
Issues of model risk
Conclusion

2. Credit Risk
Revisiting the Basel II model
Challenges and approximations of the Basel II model
Extending the Basel II model
Extending the Basel II model for sector concentration
Stochastic process
Markovian process
Building transition matixes
Regime shifting
Dependency structures
Copulas
Credit spreads
Unbundling the shape of a credit spread curve
Modelling correlation
Counterparty risk
Building the counterparty exposure profile
Conclusion

3. Insurance Risk
Insurance risks
Solvency II
Internal models
Conclusion

4. Market Risk
Stylised facts about market risk
Pricing, returns and risk premiums
Common characteristics of financial time series
Risk premiums
A common approach to derive EWMA, ARMA, ARCH and GARCH
Stochastic volatility models
Challenge of EWMA, ARMA, ARCH and GARCH models
Volatility
Value-at-risk
Recommended best practices for VaR models
Evaluation VaR models
Conclusion

5. Operational Risk
Overview of advanced measurement approach
Issues and challenges concerning loss data
Extreme-value theory
Modelling insurance
Conclusion

6. Liquidity Risk
Market liquidity risk equals systemic liquidity risk
Measuring funding liquidity risk
Measuring market liquidity risk premium – internal models for liquidity risk
Market liquidity risk premium
Implementing contingency liquidity risk planning
Conclusion

7. Correlation
Covariance, correlation and co-movement
Extremes have strong co-movements
Approaches to measuring correlation
Modelling tail dependence
Conclusion

“Today, there is a greater need than ever before for financial institutions to take an innovative, comprehensive approach to managing risk and optimizing business performance. The concept of economic capital is central to risk and performance management, and Mohan Bhatia’s book clearly describes the building blocks for quantifying risk that the world’s leading financial institutions should focus on and build strategies around.”

Charles Phillips, President, Oracle Corporation

Mohan Bhatia MS, FRM is Managing Principal heading Risk, Performance and Compliance Practice at Oracle Financial Services Consulting spearheading consulting for Basel II, Solvency II, Risk quantification and Compliance for BFSI. Mohan has provided consulting to tens of institutions in Americas, Europe, Middle East, Africa and Asia Pacific enabling them to measure and manage risk, performance and compliance. Mohan is co-editor of Journal of Risk Model Validation.