Advocates for internal model-based capital regulation argue that this approach will reduce costs and remove distortions that are created by rules-based capital regulations. These claims are examined using a Merton-style model of deposit insurance. Analysis shows that internal model-based capital...

Value-at-Risk (VaR) models often are used to estimate the equity investment that is required to limit the default rate on funding debt. Typical VaR "buffer stock" capital calculations produce biased estimates. To ensure accuracy, VaR must be modified by: (1) measuring loss relative to initial...