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Economic capital allocation under liquidity constraints

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  • Mierzejewski, Fernando

Abstract

Since the capital structure affects the performance of financial institutions confronted to liquidity constraints, the Economic Capital is determined by the maximisation of value. Allowing economic decisions to be characterised by a distorted probability distribution, so assessing the attitude towards risk as well as information and knowledge, the optimal surplus is expressed as a Value-at-Risk, as recommended by the Basel Committee. Thus, demanding more capital than regulatory requirements accounts for different expectations about risks. The optimal surplus is allocated to the lines of business of a conglomerate according to the borne risk and the type of divisional managers. Full-allocation is assured and no covariances are required. Further, a mechanism is provided, which allows for the distribution of equity in a decentralised organisation.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 2414.

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Date of creation: 01 Apr 2006
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Handle: RePEc:pra:mprapa:2414

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Keywords: economic capital; capital allocation; distorted probability principle; Value-at-Risk;

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Cited by:
  1. Mierzejewski, Fernando, 2007. "An actuarial approach to short-run monetary equilibrium," MPRA Paper 2424, University Library of Munich, Germany.
  2. Mierzejewski, Fernando, 2008. "The optimal liquidity principle with restricted borrowing," MPRA Paper 12549, University Library of Munich, Germany.
  3. Mierzejewski, Fernando, 2006. "Liquidity preference as rational behaviour under uncertainty," MPRA Paper 2771, University Library of Munich, Germany.

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