Time horizon of economic capital models

[1495_sc]

Hi,

I want to clarify the reason for having a shorter time horizon of economic capital models when risks can be hedged.

1. When we talk about time horizon for assessing economic capital, are we referring to the period over which assets and liabilities are projected for calculating capital? Wouldn't this be the same as the period until run off of liabilities irrespective of whether risks can/cannot be hedged?

2. "When risks can be hedged"- are we referring to financial risks only as insurance risks are considered to be non hedge-able?

3. Assuming the risks can be hedged- if we calculate economic capital over a shorter time period, capital requirement will be lower compared with economic capital for a longer time period. Hence, if risks can be hedged, insurer is exposed to lower risk which is why it does not make sense to hold excessive capital as would be the case if they would have calculated capital for a longer time period.

Is my understanding correct? Thank you in advance!

 

[Lindsay Smitherman]

Hi
1. If required capital were being assessed through a one-year VaR, for example, then assets and liabilities would be projected forward for one year and reassessed under each risk event at that point, thus determining the capital requirements over that one-year period.
2. Yes
3. The following thread might help to explain the point about the differing time horizons:
https://www.acted.co.uk/forums/inde...-of-economic-capital-models.18943/#post-74265