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Excess Based Allocation of Risk Capital

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  • Gulick, G. van
  • De Waegenaere, A.M.B.
  • Norde, H.W.

    (Tilburg University, Center for Economic Research)

Abstract

In this paper we propose a new rule to allocate risk capital to portfolios or divisions within a firm. Specifically, we determine the capital allocation that minimizes the excesses of sets of portfolios in lexicographical sense. The excess of a set of portfolios is defined as the expected loss of that set of portfolios in excess of the amount of risk capital allocated to them. The underlying idea is that large excesses are undesirable, and therefore the goal is to determine the allocation for which the largest excess is as small as possible. We show that this allocation rule yields a unique allocation, and that it satisfies some desirable properties. We also show that the allocation can be determined by solving a series of linear programming problems.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2010-123.

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Date of creation: 2010
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Handle: RePEc:dgr:kubcen:2010123

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Related research

Keywords: risk capital; capital allocation; excesses; lexicographic minimum;

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References

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Cited by:
  1. Boonen, T.J. & De Waegenaere, A.M.B. & Norde, H.W., 2012. "A Generalization of the Aumann-Shapley Value for Risk Capital Allocation Problems," Discussion Paper 2012-091, Tilburg University, Center for Economic Research.

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