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What are Some of the Pitfalls in Estimating Regulatory Capital?

Source: Mash Risk Television

IBM Zurich Research Lab
Dr. Eric Cope, Researcher

Runtime: 5:51

Key Takeaways:

  1. Pitfalls in Estimating Regulatory Capital:
    • Dangers involved in extrapolating beyond the observed data
    • Under-determination of models by data
    • Difficulties in applying the Loss Distribution Approach (LDA)
    • Dominance of high-severity, low-frequency categories
    • Sensitivity to the largest losses
    • Sensitivity to the loss categorization scheme
  2. Heavy-Tailed Losses Tend to Dominate Other Losses:
    • Instability of estimates: Occurrence of an extreme loss can cause estimates of the mean or variance of losses to change dramatically.
    • Dominance of sums: The sum of a set of losses is typically of the same order of magnitude as the largest single loss.
    • Dominance of mixtures: If losses from a heavy-tailed category are mixed with lighter-tailed losses, the mixture will also be heavy-tailed.

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