Risk Appetite v Risk Capacity

[Rioch]

I remain confused. Risk Appetite is how much the company wants. Risk Capacity is how much it can bear. Is Risk Capacity judged against regulatory numbers (e.g. allowed under Solvency II), whereas the Apptite could be less than this (want to be more conservative than regulators allow). Can the Risk Capacity ever be lower than the risk appetite?

Thanks y'all

 

[teddybear2012]

I remain confused. Risk Appetite is how much the company wants. Risk Capacity is how much it can bear. Is Risk Capacity judged against regulatory numbers (e.g. allowed under Solvency II), whereas the Apptite could be less than this (want to be more conservative than regulators allow). Can the Risk Capacity ever be lower than the risk appetite?

Thanks y'all

My understanding is that for those companies that are willing to take a lot risk, its risk appetite might be higher than risk capacity. Risk capacity can be determined by company's capital.

 

[ActPass]

I remain confused. Risk Appetite is how much the company wants. Risk Capacity is how much it can bear. Is Risk Capacity judged against regulatory numbers (e.g. allowed under Solvency II), whereas the Apptite could be less than this (want to be more conservative than regulators allow). Can the Risk Capacity ever be lower than the risk appetite?

Thanks y'all

Imagine you want to buy a house - base on your savings and income, you could work out, or the bank can tell you, how much you can borrow (risk capacity). In your own mind or budget plan, you could have a figure as to how much you want to pay for the mortgage (risk appetite).

Obviously some borrow more than what they can afford, in which case, the risk appetite is higher than risk capacity, but for rational investors it should be another way around.

Am I too far off track?

 

[Simon James]

The following analogy may (or may not!) help. Perhaps you can improve on it!

A friend of mine recently attended a party where he was exposed to copious amounts of a particularly nice red wine. He had a large appetite for the wine and drank a great deal. Late in the evening he had reached his capacity for drinking (even though his appetite for the wine was not yet quenched) and he went to bed. Next day, he awoke with a very sore head and realised that his tolerance for wine was not as great as he thought.

The next weekend, his appetite for wine was greatly reduced and he drank well below his capacity.

Now, the other stakeholder in this story (the chap’s wife) has a very low tolerance for my friend’s drinking and rigorously enforces limits on his drinking!

 

[Rioch]

a) Simon, if he stops himself (for whatever reason), isn't that a sign that he had reached his risk appetite (at least for that time horizon)?

 

[Quang]

My understanding is regulatory requirements like Solvency II is a factor affecting Risk Capacity, it does not determine Risk Capacity. Risk Capacity is determined by many contrainsts such as human resources, expertise, capital resources.