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An Economic Approach to Capital Allocation

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  • George Zanjani

Abstract

This article starts with primitive assumptions on preferences and risk. It then derives prices consistent with a social optimum within an insurance company and the consumer‐level capital allocation implied therein. The allocation “adds up” to the total capital of the firm (a result echoing findings in the congestion pricing literature—where optimal tolls exactly cover the rental cost of the highway). The allocation follows each consumer's share of recoveries in states of insurer default, weighted by the severity of the default in terms of welfare impact. However, the article argues that an economic approach technically restricts only the capital allocated to marginal units of coverage: inframarginal units could in principle receive different allocations.

Suggested Citation

  • George Zanjani, 2010. "An Economic Approach to Capital Allocation," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(3), pages 523-549, September.
  • Handle: RePEc:bla:jrinsu:v:77:y:2010:i:3:p:523-549
    DOI: 10.1111/j.1539-6975.2010.01354.x
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Véronique Maume-Deschamps & Didier Rullière & Khalil Said, 2014. "On capital allocation by minimizing multivariate risk indicators," Working Papers hal-01082559, HAL.
    2. Véronique Maume-Deschamps & Didier Rullière & Khalil Said, 2015. "A risk management approach to capital allocation," Working Papers hal-01163180, HAL.
    3. Stephen J. Mildenhall, 2017. "Actuarial Geometry," Risks, MDPI, vol. 5(2), pages 1-44, June.
    4. Mao Hong & Wen Zhongkai, 2018. "Optimization of Price, Default Ratio and Capital under Regulatory Criterion of Maximizing Social Benefit," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 12(2), pages 1-15, July.
    5. Matthias Fischer & Thorsten Moser & Marius Pfeuffer, 2018. "A Discussion on Recent Risk Measures with Application to Credit Risk: Calculating Risk Contributions and Identifying Risk Concentrations," Risks, MDPI, vol. 6(4), pages 1-28, December.
    6. Erel, Isil & Myers, Stewart C. & Read, James A., 2015. "A theory of risk capital," Journal of Financial Economics, Elsevier, vol. 118(3), pages 620-635.
    7. Boonen, Tim J. & Tsanakas, Andreas & Wüthrich, Mario V., 2017. "Capital allocation for portfolios with non-linear risk aggregation," Insurance: Mathematics and Economics, Elsevier, vol. 72(C), pages 95-106.
    8. Véronique Maume-Deschamps & Didier Rullière & Khalil Said, 2016. "On a capital allocation by minimizing multivariate risk indicators," Post-Print hal-01082559, HAL.
    9. Daniel Bauer & George Zanjani, 2016. "The Marginal Cost of Risk, Risk Measures, and Capital Allocation," Management Science, INFORMS, vol. 62(5), pages 1431-1457, May.
    10. pan, lingyao, 2014. "A counter cyclical adjustment on the economic capital measurement of listed commercial banks," MPRA Paper 58822, University Library of Munich, Germany.
    11. Dionne, Georges & Harrington, Scott, 2017. "Insurance and Insurance Markets," Working Papers 17-2, HEC Montreal, Canada Research Chair in Risk Management.

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