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18 - Economic capital

Published online by Cambridge University Press:  07 October 2011

Paul Sweeting
Affiliation:
University of Kent, Canterbury
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Summary

Introduction

The calculation of economic capital brings together many of the principles discussed throughout this book, covering risk measures and aggregation in particular detail. The issue of economic capital is also important to a number of departments within a financial organisation. One way to see the extent to which this is true is to consider why economic capital might be calculated. However, it is important first to understand exactly what economic capital is.

Definition of economic capital

There are a number of ways that economic capital can be defined, but most definitions contain three similar themes:

  • they refer to additional assets or cash flows to cover unexpected events;

  • they refer to an amount needed to cover these unexpected events to a specified measure of risk tolerance, with risk being measured in some way; and

  • they consider the risk over a specified time horizon.

A common definition of economic capital is the additional value of funds needed to cover potential outgoings, falls in asset values and rises in liabilities at some given risk tolerance over a specified time horizon. It can also be defined as the funds needed to maintain a particular level of solvency (ratio of assets to liabilities) or the excess of assets over liabilities, again at some given risk tolerance over a specified time horizon

Risk tolerance can also have a number of meanings, referring to a percentile of the results, a value of loss or the result of some other key indicator.

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Publisher: Cambridge University Press
Print publication year: 2011

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  • Economic capital
  • Paul Sweeting, University of Kent, Canterbury
  • Book: Financial Enterprise Risk Management
  • Online publication: 07 October 2011
  • Chapter DOI: https://doi.org/10.1017/CBO9780511844133.019
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  • Economic capital
  • Paul Sweeting, University of Kent, Canterbury
  • Book: Financial Enterprise Risk Management
  • Online publication: 07 October 2011
  • Chapter DOI: https://doi.org/10.1017/CBO9780511844133.019
Available formats
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Save book to Google Drive

To save content items to your account, please confirm that you agree to abide by our usage policies. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. Find out more about saving content to Google Drive.

  • Economic capital
  • Paul Sweeting, University of Kent, Canterbury
  • Book: Financial Enterprise Risk Management
  • Online publication: 07 October 2011
  • Chapter DOI: https://doi.org/10.1017/CBO9780511844133.019
Available formats
×