Risk Measurement, Risk Management and Capital Adequacy in Financial Conglomerates

Andrew Kuritzkes, Til Schuermann and Scott M. Weiner

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: Is there something special, with respect to risk and capital, about a financial conglomerate that combines banking, insurance and potentially other financial and non-financial activities? To what degree is the risk of the whole less than the sum of its parts? This paper seeks to address these questions by evaluating the risk profile of a typical banking-insurance conglomerate, highlighting the key analytical issues relating to risk aggregation, and raising policy considerations. Risk aggregation is the main analytical hurdle to arriving at a composite risk picture. We propose a "building block" approach that aggregates risk at three successive levels in an organization, (corresponding to the levels at which risk is typically managed). Empirically, diversification effects are greatest within a single risk factor (Level I), decrease at the business line level (Level II), and are smallest across business lines (Level III). Our estimates suggest that the incremental diversification benefits achievable at Level III are modest, around 5-10% reduction in capital requirements, depending on business mix.

Keywords: Economic capital; financial regulation; risk aggregation (search for similar items in EconPapers)
JEL-codes: G18 G28 (search for similar items in EconPapers)
Date: 2002-11
New Economics Papers: this item is included in nep-cfn, nep-fin and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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