On slide 66 of Episode 10 you subtract the expected loss when calculating the VaR. Could you explain why? In my view not subtracting the mean would give a more pure VaR. If anything, I would understand adding the expected loss instead of subtracting it…

Ened,

In both credit and operational risk, economic capital = VaR(confidence) - expected loss (EL). For both, following regulatory capital, the basic idea is that the bank will cover expected losses (EL) already in the normal course of doing business (e.g., those losses will tend to be covered by operating expenses). This is thematic; although i didn’t label it as such on that XLS - the key idea is that economic capital/regulatory capital covers unexpected losses (UL) and UL = VaR(confidence) - expected loss (EL).

David

Sure, but in this case we were solving for the VaR, not the UL, right?

No, I should have labeled them UL @ 95th percentile VaR and UL @ 99th percentile VaR - if you understand the above, it sounds like you know what i mean. David