Which of the following is NOT an approach to determine risk margins?

• A. VaR
• B. TVaR
• C. Cost of capital method
• D. Scenario-based budgeting not described

Answer: (D)

Determining risk margins uses methods that quantify potential losses or the cost of absorbing risk. VaR provides a threshold loss level at a chosen confidence, giving a clear target for reserves. TVaR goes further by averaging losses that occur beyond that VaR threshold, capturing tail risk and often producing more robust margins in heavy-tailed situations. The cost of capital method ties the margin to the expense of holding capital to support uncertainty, reflecting the return that capital must earn to compensate for risk.

Scenario-based budgeting, while valuable for planning under different future conditions, isn’t a formal technique for setting risk margins. It projects budgets across scenarios but doesn’t directly measure distributional losses or the cost of capital, so it doesn’t yield a principled risk margin. Hence, scenario-based budgeting is not an approach used to determine risk margins.