How might one determine if a financial institution is taking risk in a balanced and productive manner? A powerful tool to address this question is economic capital, which is a model-based measure of the amount of equity that an entity must hold to satisfactorily offset its risk-generating activities. This book, with a particular focus on the credit-risk dimension, pragmatically explores real-world economic-capital methodologies and applications. It begins with the thorny practical issues surrounding the construction of an (industrial-strength) credit-risk economic-capital model, defensibly determining its parameters, and ensuring its efficient implementation. It then broadens its gaze to examine various critical applications and extensions of economic capital; these include loan pricing, the computation of loan impairments, and stress testing. Along the way, typically working from first principles, various possible modelling choices and related concepts are examined. The end resultis a useful reference for students and practitioners wishing to learn more about a centrally important financial-management device.

Chapter 1. Introducing Economic Capital

Part 1. Modelling Credit-Risk Economic Capital
Chapter 2. Constructing a Practical Model
Chapter 3. Finding Model Parameters
Chapter 4. Implementing The Model
Part 2. Loan Pricing
Chapter 5. Approximating Economic Capital
Chapter 6. Loan Pricing
Part 3. Modelling Expected Credit Loss
Chapter 7. Default-Probability Fundamentals
Chapter 8. Building Stress Scenarios
Chapter 9. Computing Loan Impairments
Part 4. Other Practical Topics
Chapter 10. Measuring Derivative Exposure
Chapter 11. Seeking External Comparison
Chapter 12. Thoughts on Stress Testing.