Total market riskTotal market risk

Total market risk

Depending on the nature and capability of the risk measurement system in place, ADIs using the internal models approach should employ one of the following three methods to calculate a capital charge.

Method one: ADIs using this method calculate a total value-at-risk (VaR) number across those asset classes to which the internal model applies. In calculating this number, ADIs will have discretion to recognise correlations both within and across asset classes.

Method two: ADIs may calculate individual VaR numbers for each asset class separately. Again, ADIs have the option of incorporating into the calculation correlations between instruments within an asset class. The total VaR measure is the sum of the measures for each asset class.

Method three: If an ADI’s risk measurement system is structured in such a way that the ADI has the capacity to calculate VaR measures both across and within asset classes (i.e. a combination of method one and method two) then the ADI should report the VaR numbers determined using both methods. Owing to diversification effects, the capital charge which results from calculating a VaR measure across all asset classes (i.e. method one) will be lower than the capital charge which results from calculating VaR measures for individual asset classes and summing them (i.e. method two). The capital requirement will be based on method one.