Optimal capital allocation principles
AbstractThis paper develops a unifying framework for allocating the aggregate capital of a financial firm to its business units. The approach relies on an optimisation argument, requiring that the weighted sum of measures for the deviations of the business unit’s losses from their respective allocated capitals be minimised. This enables the association of alternative allocation rules to specific decision criteria and thus provides the risk manager with flexibility to meet specific target objectives. The underlying general framework reproduces many capital allocation methods that have appeared in the literature and allows for several possible extensions. An application to an insurance market with policyholder protection is additionally provided as an illustration.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 13574.
Date of creation: 23 Jan 2009
Date of revision:
Capital allocation; risk measure; comonotonicity; Euler allocation; default option; Lloyd’s of London;
Other versions of this item:
- G00 - Financial Economics - - General - - - General
- G20 - Financial Economics - - Financial Institutions and Services - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-02-28 (All new papers)
- NEP-CFN-2009-02-28 (Corporate Finance)
- NEP-IAS-2009-02-28 (Insurance Economics)
- NEP-RMG-2009-02-28 (Risk Management)
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