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Risk Measurement, Risk Management and Capital Adequacy in Financial Conglomerates

  • Andrew Kuritzkes
  • Til Schuermann
  • Scott M. Weiner

Is there something special, with respect to risk and capital, about a financial conglomerate that combines banking, insurance and potentially other financial and non-financial activities? To what degree is the risk of the whole less than the sum of its parts? This paper seeks to address these questions by evaluating the risk profile of a typical banking-insurance conglomerate, highlighting the key analytical issues relating to risk aggregation, and raising policy considerations. Risk aggregation is the main analytical hurdle to arriving at a composite risk picture. We propose a "building block" approach that aggregates risk at three successive levels in an organization, (corresponding to the levels at which risk is typically managed). Empirically, diversification effects are greatest within a single risk factor (Level I), decrease at the business line level (Level II), and are smallest across business lines (Level III). Our estimates suggest that the incremental diversification benefits achievable at Level III are modest, around 5-10% reduction in capital requirements, depending on business mix.

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File URL: http://fic.wharton.upenn.edu/fic/KSW%20Financial%20Conglomerates%201.3.pdf
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Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 03-02.

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Date of creation: Nov 2002
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Handle: RePEc:wop:pennin:03-02
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