Economic and Regulatory Capital for Financial Institutions
Suppose that at time t, a speculator invests a capital amount of S(t) dollars in the stock market. He expects a return 〈δSτ(t)〉 on a time scale τ. In the preceding chapter, we discussed the risk associated with this position, i.e. to what extent the actual return δSτ(t) may deviate from the expected outcome 〈δSτ(t)〉.
The present chapter is concerned with the inverse problem. Given a certain risk of a bank, how can the bank ensure that it can safely take this risk, i.e. that the risk poses no threat to the prosperity or even the survivial of the bank. This is all the more important as the risk may not necessarily arise from speculative proprietary trading but simply from the bank’s day-to-day business with its customers.
KeywordsCredit Risk Operational Risk Capital Requirement Market Risk Default Probability
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