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As per my understanding, the Regulatory capital for a Financial institution is calculated as sum of Market risk, Credit risk, and Ops risk.

However, in most cases, the Market risk is calculated as 10 days horizon and Credit risk for 1 year horizon.

Then how can these 2 measures be additive to come up with a single measure for capital?

I appreciate your insight.

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There is a significant amount of literature on this topic ("risk integration") and a number of different approaches have been proposed. A relatively accessible introduction to this topic (See Chapter 7 in particular) can be found here: Stress Testing and Risk Integration in Banks. At a high level, adding the risk measures involves estimating the loss distributions of the different risk factors at their planning horizons (which are a function of their individual liquidity horizons), modeling their correlations, and making some assumption as to how the more liquid portfolios are rolled over at the end of each planning period. For example, a one-year planning period might be split up into 12 months for a very liquid trading book.

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  • $\begingroup$ Thanks for the book reference. However still am not very clear on the aggregation of different risk classes (not the aggregation of different risk variables). Hope this book will give some references. However any other points are highly welcome $\endgroup$ Dec 9 '20 at 7:13

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