Risk profile/measure/tolerance

[zuglubuglu]

I am still getting confused with this. If for example we are using a standard Solvency II model to calculate the 99.5% VaR, then would it correct to say that

• the risk profile is the whole balance sheet or rather Assets - Liabilities
• the risk measure is the VaR(99.5%) over the next year, and
• the risk tolerance is 99.5%?

 

[maz1987]

My understanding is that the risk profile is the distribution of possible outcomes (it does not have to be just assets - liabilities = free reserves, it can be gross loss, net loss, ... anything really).

The risk measure in this example is the financial value of the 99.5% VaR.

The risk tolerance is therefore the maximum amount they are willing for this value to be.

For example, the 99.5% VaR of net loss under a particular set of mitigation techniques is GBP1bn, but the company may only have a risk tolerance of GBP800m. Therefore the mitigation techniques need to be adapted/added to in order to reduce the GBP1bn down to at most GBP800m.

But I'm still studying the course so maybe one of the ActEd guru's could confirm!

edit: I've done a bit more reading around the topic and seems my interpretation wasn't correct - the tolerance is indeed the level of confidence (i.e. 99.5% in this example).

 

[Darren Michaels]

These terms are covered in Section 1.4 of Chapter 19 of the Course Notes.

The risk profile are the risks that have been modelled along with the outcome that is being measured. In your example the outcome would be the balance sheet at the end of next year showing a surplus of no less than zero.

The risk measure is how much capital is needed to achieve that outcome with a given probability, the risk tolerance.