A direct application of RaRoC and SVA is to determine the appropriate customer price given risk. The approach is identical to the one used to derive price from a target Return On Equity (ROE) applied to the regulatory capital.
Ex post measures use absolute risk contributions and serve for risk-return monitoring of the existing portfolio (ex post view). Ex ante measures use marginal risk contributions and serve for risk-based pricing (ex ante view).
The three chapters use the same sample fictitious portfolio for illustrative purposes. This section briefly summarizes the characteristics of the portfolio.
The portfolio overview provides some basic aggregated characteristics of the risk-reward profile. Table 55.1 summarizes some of these aggregated characteristics. The loss given default percentages have a direct and very significant effect on losses, but exposures serve to normalize the data since the spreads are exposure-based.
Both correlation risk and concentration risk are related measures of portfolio risk. Correlation risk relates to the loss association. Concentration risk designates here the effect of size discrepancies. Pure correlation risk is measured by the 30% asset correlation, independent of the sizes of exposures.
Capital allocation figures are ex post absolute risk contributions, or simpler alternative metrics, such as standalone loss volatilities of facilities. In this example, the capital allocation criterion is the standalone loss volatility (equivalent in this case to using risk contributions). The loss volatility of each facility is Lgd x VEdf(l — Edf). It is an […]
Risk information has several characteristics making risk data management a serious challenge: risks are multidimensional, they need interactive investigation by end-users and require moving back and forth from synthetic Value at Risk (VaR) to underlying sources of risk. Identifying the sources of risk conditions the ability to hedge risks, since we cannot hedge directly synthetic […]
The basic risk measures used are: • Exposure, either in value or as a percentage of total portfolio exposure. • Capital in excess of expected loss, either in value or as a percentage of total portfolio capital.
Our sample reports use industry and business units as management dimensions and grouping criteria, cross-tabulated with risk and return measures. Using industry and business units we show risks and performance. The risk dimensions include:
We consider a two-segment portfolio, with two exposures: A is an existing exposure, and B is a new exposure of varying size. We examine what happens in terms of return on economic capital when the additional B exposure increases, while its AIS in percentage or, equivalently, its Return on Assets (ROA) remains constant.
