Defining and measuring business risk in an economic‐capital framework

Purpose - The objectives of this paper are to: define business risk; identify whether economic capital could be used to mitigate this risk; and investigate business‐risk measurement methodologies. Design/methodology/approach - The paper analyzes definitions used in theory and practice and derived a definition. It analyzes three measurement methodologies: analogue companies/peer group analysis, statistical methods, and scenario analysis. These methodologies are tested against the criteria of effective management control, because economic capital is increasingly used as a management control instrument. Findings - Economic capital can be used as business‐risk mitigant albeit not the only one. The measurement methodology of scenario analysis satisfies most of the criteria for effective control. Practical implications - This paper opens a discussion to further develop the scenario approach in theory and practice. Originality/value - Despite the amount of economic capital that financial institutions hold to cover business risk, it has received little attention in literature. This paper opens a discussion on a relatively new field of research.