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Risk capital allocation for RORAC optimization

Author

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  • Buch, Arne
  • Dorfleitner, Gregor
  • Wimmer, Maximilian

Abstract

This paper considers the financial optimization problem of a firm with several sub-businesses striving for its optimal RORAC. An insightful example shows that the implementation of classical gradient capital allocation can be suboptimal if division managers are allowed to venture into all business whose marginal RORAC exceeds the firm's RORAC. The marginal RORAC requirements are refined by adding a risk correction term that takes into account the interdependencies of the risks of different lines of business. It is shown that under certain stationarity conditions this approach can guarantee that the optimal RORAC will eventually be achieved.

Suggested Citation

  • Buch, Arne & Dorfleitner, Gregor & Wimmer, Maximilian, 2011. "Risk capital allocation for RORAC optimization," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3001-3009, November.
  • Handle: RePEc:eee:jbfina:v:35:y:2011:i:11:p:3001-3009
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Glaser, Markus & Riepe, Jan, 2014. "Internal capital market studies in empirical banking: Biases due to usage of assets instead of risk capital?," Finance Research Letters, Elsevier, vol. 11(1), pages 47-53.
    2. repec:mnb:finrev:v:16:y:2017:i:3:p:74-97 is not listed on IDEAS
    3. Véronique Maume-Deschamps & Didier Rullière & Khalil Said, 2014. "On capital allocation by minimizing multivariate risk indicators," Working Papers hal-01082559, HAL.
    4. Véronique Maume-Deschamps & Didier Rullière & Khalil Said, 2015. "A risk management approach to capital allocation," Working Papers hal-01163180, HAL.
    5. Alexandru V. Asimit & Raluca Vernic & Riċardas Zitikis, 2013. "Evaluating Risk Measures and Capital Allocations Based on Multi-Losses Driven by a Heavy-Tailed Background Risk: The Multivariate Pareto-II Model," Risks, MDPI, Open Access Journal, vol. 1(1), pages 1-20, March.
    6. Agata Gemzik-Salwach, 2012. "The Use Of A Value At Risk Measure For The Analysis Of Bank Interest Margins," "e-Finanse", University of Information Technology and Management, Institute of Financial Research and Analysis, vol. 8(4), pages 15-29, February.
    7. Olivier Bruno & André Cartapanis & Eric Nasica, 2013. "Bank leverage, financial fragility and prudential regulation," Working Papers halshs-00853701, HAL.
    8. 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.
    9. Véronique Maume-Deschamps & Didier Rullière & Khalil Said, 2016. "On capital allocation by minimizing multivariate risk indicators," Post-Print hal-01082559, HAL.
    10. Belles-Sampera, Jaume & Guillén, Montserrat & Santolino, Miguel, 2014. "GlueVaR risk measures in capital allocation applications," Insurance: Mathematics and Economics, Elsevier, vol. 58(C), pages 132-137.

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