Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. 14 IV. MARKET RISK 4.1 Definition of Market Risk Market risk is broadly defined as the potential loss in value from adverse movement of market price variables, such as energy prices, foreign exchange, and interest rates (hereinafter referred to as price movements or price behavior) over a defined time horizon. This potential loss in value, or market risk, over the period in which capital adequacy is to be assessed is one component of total economic capital. The processes for estimating (commodity, interest rate, and foreign exchange) price behaviors are integral in assessing the market risk, credit risk, and operative risk2 components of total economic capital and liquidity (Figure 7). Figure 7: Applicability of Process for Estimating Price Behavior3 2 For instance, market prices are used to calculate replacement costs when forced outages occur, assuming insurance against those outages is not in place. 3 Price can be driven by weather, load, and variable volume. P r o c e s s f o r E s t im a t in g P r ic e B e h a v io r M a r k e t R is k E x p o s u r e M a p C r e d it R is k E x p o s u r e M a p L iq u id it y R is k E x p o s u r e M a p M a r k e t R is k C r e d it R is k O p e r a t iv e R is k E c o n o m ic C a p it a l L iq u id it y O p e r a t iv e R is k E x p o s u r e M a p