Risk Capital Attribution and Risk-Adjusted Performance Measurement (FRM Part 2 – Book 3 – Ch 12)

Описание: Master Risk Capital Attribution and Risk-Adjusted Performance Measurement (RAROC) for FRM Part 2 (Book 3, Ch. 12). We clarify risk capital vs. economic/regulatory capital, show how to compute RAROC with a full banking example, link it to hurdle rates and CAPM, and discuss VaR scaling (square-root-of-time), capital allocation, diversification benefits, and best practices.

You’ll learn to:
Define risk, economic, and regulatory capital and their purposes.
Compute and interpret RAROC and adjusted RAROC.
Set and test a hurdle rate (cost of equity via CAPM, preferred equity).
Treat risk capital as VaR and annualize via the square-root-of-time rule.
Allocate capital across business lines and handle diversification effects.

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After completing this reading, you should be able to:
Define, compare and contrast risk capital, economic capital and regulatory capital, and explain methods and motivations for using economic capital approaches to allocate risk capital.
Describe the RAROC (risk-adjusted return on capital) methodology and its use in capital budgeting.
Compute and interpret the RAROC for a project, loan, or loan portfolio and use RAROC to compare business unit performance.
Explain challenges that arise when using RAROC for performance measurement, including choosing a time horizon, measuring default probability and choosing a confidence level.
Calculate the hurdle rate and apply this rate in making business decisions using RAROC.
Compute the adjusted RAROC for a project to determine its viability.
Explain challenges in modeling diversification benefits, including aggregating a firm’s risk capital and allocating economic capital to different business lines.
Explain best practices in implementing an approach that uses RAROC to allocate economic capital

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