Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

The aggregation of risks, Proposal I

As a first approach to compute total risk, one could just take the mathematical sum of each individual risk:

Total risk = EAR_$book + EAR_€book = $100 + $300 = $400

Simple mathematics! No error. However, one will quickly argue that taking the sum of each risk is really looking at the worst-case scenario, that is how much does e-Bank lose if, at the same time, the dollar interest rate goes in the wrong direction (in the example, down) and the euro interest rate goes into the wrong direction (in the example, up). One might say that, although it might be interesting to know the potential loss under a worst-case scenario, it is unlikely that the dollar rate will go down at the same time as the euro rate goes up. ...