After the credit crunch: How much capital is enough?

With several large banks in the US and elsewhere effectively insolvent, all banks are now focusing on the question of their economic capital: how much capital must a financial institution have on hand to survive in a worst-case scenario? Naturally, this is an assessment of risk. How, exactly, that risk is calculated is the focus of a white paper by  John Morrison, Solution Architect in Rick Management at Asymptotix. (REvolution Computing also provided support for this white paper.) Obviously, failure to quantify this risk correctly was a major contributor to the credit crunch, in particular the practice of packaging debt into derivatives. Says John:

The paper is intensely detailed and supported by myriad references, and perhaps more suited to those with a background in risk than as an overview of the credit crisis and estimation of economic capital. In section 5.6 is does give some practical steps for using R to implement a stress test for economic capital, so if you’ve thought about using R for risk analysis but needed a good jumping-off point, this might be a good place to start. There are some also some excellent examples of customized R charts used to illustrate concepts in the paper, such as the one shown below.