Excess based allocation of risk capital
van Gulick,G. De Waegenaere,A.M.B. Norde,H.W.
van Gulick,G.
De Waegenaere,A.M.B.
Norde,H.W.
Abstract
In this paper we propose a new rule to allocate risk capital to portfolios or divisions within a firm. Specifically, we determine the capital allocation that minimizes the excesses of sets of portfolios in a lexicographical sense. The excess of a set of portfolios is defined as the expected loss of that set of portfolios in excess of the amount of risk capital allocated to them. The underlying idea is that large excesses are undesirable, and therefore the goal is to determine the allocation for which the largest excess is as small as possible. We show that this allocation rule yields a unique allocation, and that it satisfies some desirable properties. We also show that the allocation can be determined by solving a series of linear programming problems.
Description
Appeared earlier as CentER Discussion Paper 2010-123
Date
2012
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Citation
van Gulick, G, De Waegenaere, A M B & Norde, H W 2012, 'Excess based allocation of risk capital', Insurance Mathematics & Economics, vol. 50, no. 1, pp. 26-42. https://doi.org/10.1016/j.insmatheco.2011.09.003