Optimal Capital Allocation Principles

Optimal Capital Allocation Principles

Evaluating capital requirements as well as allocating total capital into various business units are becoming increasingly important part of the risk management process of a financial enterprise. In the allocation of capital, we consider the purpose of capital allocation within a company (individual, collective, or market-relative), the manner in which the portfolios within the conglomerate can ...

Optimal Capital Allocation

This paper starts with primitive assumptions on consumer preferences and then derives prices consistent with a social optimum within an insurance company and the capital allocation implied therein. The implied allocation “adds up” to the total capital of the …rm (a result echoing …ndings in the congestion pricing literature— where optimal tolls exactly cover the rental cost of the highway). The...

Optimal Capital Allocation: Mean-Variance Models

This paper studies capital allocation problem based on minimizing loss functions. Two capital allocation models based on the Mean-Variance principle are proposed. General formulas for optimal capital allocations for both models are derived according to quadratic distance measure. In particular, we discuss centrally symmetric distributions and gamma distributions. Some numerical examples are giv...

Risk Based Capital Allocation

An application of capital allocation principles to operational risk and the cost of fraud

The costs of operational risk refer to the capital needed to cover the losses generated by a firm’s ordinary activities. In this paper several capital allocation principles are examined to demonstrate how such principles can be used to distribute aggregated capital across the various constituents that generate operational risk. Proportional allocation, for example, allows a cost per unit to be ...