Definition of rarorac

Risk adjusted return on risk adjusted capital (rarorac) combines both raroc and rorac to create an easy yardstick for comparing the relative risks and returns of various activities. But its accuracy depends on the models used to estimate risk and capital, such as Value at Risk. This measure became popular after the Basel Committee on Banking Supervision began requiring banks to apply risk adjustments to the way they calculated their capital stock.

Rorac is often used when the risk varies depending on the kind of capital invested. In the 2007-8 financial crisis, many banks found that their estimates had understated the risks they were running, particularly in complex structured products.  [1]

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