Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. 62 To illustrate the different risk management activities described, a pyramid represents the levels outlined above. Assessment Economic Value For each level of risk management activities, the example quantitatively analyzes not only the economic capital required for market, credit, and operative risk, but also the effect of diversification and the resulting total required economic risk capital. When appropriate, required capital and the diversification effect are reflected under three methods (square root sum of squares, Monte Carlo simulation, and simple sum) of calculating combined capital as outlined in the white paper. Financial Liquidity The example also addresses the relationship between market and liquidity risk. Attention is paid to trigger events such as credit downgrades and how actions taken to reduce market risk may increase liquidity risk. We describe the impact this has on companies when trying to balance short-term liquidity requirements with long-term economic objectives. U nhedged A ssets A p plication of H edging D evelopm ent of A sset P ortfolio P ortfolio E ffect on C om ponent R isk D iversification B enefits Across R isks Low er H igher C om plexity of R isk M easurem ent U nhedged A ssets A p plication of H edging D evelopm ent of A sset P ortfolio P ortfolio E ffect on C om ponent R isk D iversification B enefits Across R isks Low er H igher C om plexity of R isk M easurem ent