Economic capital estimation for market risk requires a bank to extend its estimate of risk based on a smaller time horizon, n, which is generally one or ten days to a longer horizon, N, which is generally one year. This would require modeling of the possible changes in the portfolio over the horizon and calculation of the corresponding impact on the long-term loss distribution. Once the long-term distribution has been extended, economic capital can be estimated using various risk measures. The standard method used for extending economic capital based on a commonly used risk measure, Value-at-Risk (VaR), from n to N days is scaling it up by a factor of Ö(N/n). This paper adopts a different approach for extending the loss distribution. Rather than making assumptions regarding the nature of portfolio loss distributions across time and the risk measures used, optimal portfolio instrument weights relevant to the risk behavior of the trading desk historically, is calculated. This would require solving for optimal portfolio selection given the risk behavior of the desk and can potentially incorporate various other constraints such as limits on positions and portfolio amounts.

Debt as a financial instrument is designed to be risk-free for the lender except in the event of the borrower's combined assets falling short of the debt payment due. This in the world of limited liability equity investors, means that value of their equity investment is the greater of zero or the residual "assets" after paying off all the debt holders. In an ideal world the market value of an organization's assets should be sufficient to cover its debt due at a certain time in future, despite possible erosions in the organization's equity as a result of its risk-taking activities. This horizon should be big enough for a bank to raise fresh equity (to counter the possible erosions), if required, or to alter its "risk" profile (to limit the possible erosions).

"Risk" as an abstract concept, can be considered equivalent to "uncertainty" and given some qualitative understanding, it can be used in principle to distinguish a more risky enterprise from a less risky one. It can also be used to arrange three or more enterprises in a decreasing order of risk, but it is rather difficult to say which two differ by the greatest extent. Quantification of risk provides us with this additional scope. Further, a quantitative measure of risk, henceforth referred to as a risk measure, should be able to provide us indirectly with an adequate level of equity corresponding to a firm's debt and risk profile.

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