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Optimal capital allocation principles

Author

Listed:
  • Dhaene, Jan
  • Tsanakas, Andreas
  • Emiliano, Valdez
  • Steven, Vanduffel

Abstract

This 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.

Suggested Citation

  • Dhaene, Jan & Tsanakas, Andreas & Emiliano, Valdez & Steven, Vanduffel, 2009. "Optimal capital allocation principles," MPRA Paper 13574, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:13574
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    Keywords

    Capital allocation; risk measure; comonotonicity; Euler allocation; default option; Lloyd’s of London;

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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