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Optimal capital allocation in a hierarchical corporate structure

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  • Zaks, Yaniv
  • Tsanakas, Andreas

Abstract

We consider capital allocation in a hierarchical corporate structure where stakeholders at two organizational levels (e.g., board members vs line managers) may have conflicting objectives, preferences, and beliefs about risk. Capital allocation is considered as the solution to an optimization problem whereby a quadratic deviation measure between individual losses (at both levels) and allocated capital amounts is minimized. Thus, this paper generalizes the framework of Dhaene et al. (2012), by allowing potentially diverging risk preferences in a hierarchical structure. An explicit unique solution to this optimization problem is given. In several examples, it is shown how the optimal capital allocation achieves a compromise between conflicting views of risk within the organization.

Suggested Citation

  • Zaks, Yaniv & Tsanakas, Andreas, 2014. "Optimal capital allocation in a hierarchical corporate structure," Insurance: Mathematics and Economics, Elsevier, vol. 56(C), pages 48-55.
    • Handle: RePEc:eee:insuma:v:56:y:2014:i:c:p:48-55
    DOI: 10.1016/j.insmatheco.2014.02.009
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    References listed on IDEAS

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    Cited by:

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    2. Cai, Jun & Wang, Ying, 2021. "Optimal capital allocation principles considering capital shortfall and surplus risks in a hierarchical corporate structure," Insurance: Mathematics and Economics, Elsevier, vol. 100(C), pages 329-349.
    3. Boonen, Tim J. & Guillen, Montserrat & Santolino, Miguel, 2019. "Forecasting compositional risk allocations," Insurance: Mathematics and Economics, Elsevier, vol. 84(C), pages 79-86.
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    5. Kamil J. Mizgier & Joseph M. Pasia, 2016. "Multiobjective optimization of credit capital allocation in financial institutions," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 24(4), pages 801-817, December.
    6. Jilber Urbina & Miguel Santolino & Montserrat Guillen, 2021. "Covariance Principle for Capital Allocation: A Time-Varying Approach," Mathematics, MDPI, vol. 9(16), pages 1-13, August.
    7. Martin Eling & Ruo Jia, 2017. "Recent Research Developments Affecting Nonlife Insurance—The CAS Risk Premium Project 2014 Update," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 20(1), pages 63-77, March.
    8. Major, John A., 2018. "Distortion measures and homogeneous financial derivatives," Insurance: Mathematics and Economics, Elsevier, vol. 79(C), pages 82-91.

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