Belgian Actuarial Bulletin, Vol. 5, pp. 52-56, 2005
30 Pages Posted: 19 May 2009
In this paper we analyze and evaluate a standard approach financial institutions use to calculate their so-called total economic capital.
If we consider a business that faces a total random loss S over a given one-year horizon then economic capital is traditionally defined as the difference between the 99.97% percentile of S and its expectation. The standard approach essentially assumes that the different components (risks) of S are multivariate normally distributed and this highly facilitates the computation of the total aggregated economic capital.
In this paper we show that this approach also holds for a more general framework which encompasses as a special case the multivariate normal (and elliptical) setting. We question also the assumption of multivariate normality since for many risks one often assumes other than normal distributions (e.g. a lognormal distribution for insurance risk). Assuming that risks are either normal or lognormal distributed we propose, using the concept of comonotonicity, an alternative aggregation approach.
Keywords: economic capital, aggregation, Solvency II, Basel II, VaR
Suggested Citation: Suggested Citation
Dhaene, Jan and Goovaerts, M. J. and Lundin, Mark and Vanduffel, Steven, Aggregating Economic Capital. Belgian Actuarial Bulletin, Vol. 5, pp. 52-56, 2005 . Available at SSRN: https://ssrn.com/abstract=1406868