Risk Aggregation for Capital Requirements Using the Copula Technique

In order to determine the appropriate amount of capital for an organization, risks must be aggregated appropriately to reflect the non-normality of individual risks and nonlinear dependence among risks, particularly in the tails of risk distributions. In this article, we start with a brief overview of the MCCSR approaches and Correlation Matrix approach. Secondly, general introductions of the Copula technique are provided. We then elaborate on one type of popular Copula that has good application in risk aggregation for capital requirement purpose, t-Copula. Gaussian Copula is also briefly discussed. Finally, a numerical example is provided.