The approach to estimating capital and the market risk of portfolios is a bit confused at the moment. If we think of capital as the buffer that we need to hold against some surprisingly bad event, then it makes no sense to estimate it by looking at current and past portfolios. The Board needs to tell the traders how much money it wants to put at risk from a trading portfolio. Then the risk model can assess the probability of this occurring given the current portfolio and current market conditions to ensure that the VaR limit is within the Board approved limits.
How does the Board come to its decision? Gut feel can be one way. Another would be to look at the historical risk positions that have been taken. Both approaches need to be reconciled.
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