Economic Capital

Economic capital is the amount of capital that a company needs to have in order to survive a severe financial crisis. It is calculated by taking into account the company's assets, liabilities, and risks.

There are two main types of economic capital: regulatory capital and risk-based capital. Regulatory capital is the amount of capital that a company is required to hold by regulators. Risk-based capital is the amount of capital that a company needs to hold in order to cover its potential losses.

Economic capital is important because it helps companies to manage their risk and to ensure that they have enough capital to survive a financial crisis. By calculating their economic capital, companies can identify their most significant risks and take steps to mitigate those risks.

There are a number of different methods for calculating economic capital. The most common method is the Value-at-Risk (VaR) method. The VaR method estimates the maximum amount of loss that a company can expect to suffer over a given time period with a given level of confidence.

Another method for calculating economic capital is the Expected Shortfall (ES) method. The ES method estimates the average amount of loss that a company can expect to suffer over a given time period with a given level of confidence.

The choice of which method to use for calculating economic capital depends on the company's specific needs and risk profile.

Economic capital is an important concept for understanding how companies manage their risk. By calculating their economic capital, companies can ensure that they have enough capital to survive a financial crisis and to continue operating in the long term.