Calibrating Your Intuition: Capital Allocation for Market and Credit Risk
IMF Working Papers, May 1, 2002
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- Calibrating Your Intuition: Capital Allocation for Market and Credit Risk
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Bibliographic details
- Authors: Paul H. Kupiec
- Published: May 1, 2002
- Series: IMF Working Papers
Summary findings
- Value-at-Risk (VaR) models are often used to estimate the equity investment required to limit the default rate on funding debt.
- Typical VaR "buffer stock" capital calculations produce biased estimates.
- To ensure accuracy, VaR must be modified by:
- (1) measuring loss relative to initial market value; and
- (2) augmenting VaR to account for the interest income required by investors.
- While this issue has been identified in the market risk setting, it has yet to be recognized in the credit risk literature.
- Credit VaR techniques, as typically described, are not an appropriate basis for setting equity capital allocations.
Methodological adjustments to VaR
- Measure losses relative to initial market value instead of alternative baselines.
- Augment VaR to include the interest income required by investors when calculating necessary equity.
- The combination of these two modifications addresses biases found in typical "buffer stock" capital calculations.
Implications for credit risk and capital allocation
- The recognition that standard VaR calculations are biased implies that commonly used Credit VaR techniques are unsuitable for determining equity capital allocations.
- Policymakers and risk managers should not rely on Credit VaR techniques as typically described for setting equity capital without applying the identified modifications.
Publication and metadata
- Title: Calibrating Your Intuition: Capital Allocation for Market and Credit Risk
- Author: Paul H. Kupiec
- Date: May 1, 2002
- Series: Working Paper No. 2002/099
- Issue: 099
- Volume: 2002
- Pages: 23
- Stock No: WPIEA0992002
- ISBN: 9781451852288
- ISSN: 1018-5941
- Preview citation format shown: Paul H. Kupiec "Calibrating Your Intuition: Capital Allocation for Market and Credit Risk", IMF Working Papers 2002, 099 (2002), accessed 9/17/2026
IMF Working Paper — Calibrating Your Intuition: Capital Allocation for Market and Credit Risk, Paul H. Kupiec (Working Paper No. 2002/099, May 1, 2002).
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- Calibrating Your Intuition: Capital Allocation for Market and Credit Risk - WP/02/99