Financial Risk Manager Part 2
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The Chief Risk Officer (CRO) of an investment firm is considering methods to consolidate risks across the firm's trading and banking portfolios. The CRO has requested that an analyst prepare a comparison between the segmented approach and the integrated approach to risk consolidation. The firm's extensive lending activities and trading operations span multiple countries, leading to significant and diverse trading and banking books. Given this context, which of the following statements accurately reflects aspects of the segmented approach or the integrated approach to risk management?
A
One argument in support of the compartmentalized approach is that it gives a reasonable lower bound for economic capital. Estimating the capital required for various individual risk types using the compartmentalized approach allows the bank to account for any possible correlations between the risk types.
B
The compartmentalized approach is a non-integrated approach in which the capital required for each risk type is estimated separately and then summed to find the capital required for the bank as a whole, without regard to any correlations or interactions.
C
Since each holding in the bank's portfolio can easily be assigned to a specific risk type, the unified approach is typically the preferred approach to estimating economic capital.
D
Using the unified approach may allow the bank to benefit from diversification effects that lead to lower capital requirements.