Excess Based Allocation of Risk Capital

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 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.risk capital;capital allocation;excesses;lexicographic minimum

Risk based capital allocation

In this paper, we focus on the economic research of corruption. In the first part, we define corruption, types of corruption, its factors and ways to measure it. This section brings together various definitions by notable authors of this domain, such as Begovic, Tanzi, Mauro or Lambsdorff. Before moving to the second section, we are presenting definitions, typologies and factors already researched by acclaimed authors. In the second part, we focus on the channels by which corruption transmits its effects through the economy. This section consists of two major sub-parts, the first one in which we take part in a vivid scientific discussion with the ‘’apologists’’ of corruption, i.e. with those economists who underline positive roles of corruption. In the second sub-part of the second section, as a logic continuation of the previous sub-part, we are listing three important consequences of rampant corruption in one economy: consequences to economic growth, foreign direct investments and economic efficiency. Major contribution of this paper is compilation of significant scientific discoveries in the area, as well as bringing new arguments in the discussion on the economic consequences of corruption. The paper uses traditional approach of the New institutional economics (NIE), by underlining the importance of governance, transaction costs and rent seeking.corruption, institutional capacities, new institutional economics, transaction costs, FDI

Managing economic and virtual economic capital within financial conglomerates.

In the present contribution we show how the optimal amount of economic capital can be derived such that it minimizes the economic cost of risk-bearing. The economic cost of risk-bearing takes into account the cost of the economic capital as well as the cost of the residual risk. In addition to the absolute problem of the determination of the amount of economic capital, we also consider the relative problem of how to establish the allocation of economic capital among subsidiaries. However, since subsidiaries are juridical entities they will also solve the problem of economic capital allocation themselves. Clearly, in an equilibrium situation the relative allocation derived by the conglomerate and the absolute allocation derived by the subsidiaries coincide. We show that the diversification benefit which is typically obtained in a conglomerate construction, creates a virtual economic capital for subsidiaries within the conglomerate. We show furthermore that the absolute allocation approach can also be applied to the problem of optimal portfolio selection, extending the well-known Markovitz approach and providing a tool for management by economic capital.Capital allocation; Construction; Equilibrium; Management; Optimal; Optimal portfolio selection; Portfolio; Risk; Risk management; Selection; Subsidiaries;

Optimal capital allocation principles

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

Agglomeration tendencies in EU regions: where does capital go?

This paper focuses on two aspects being neglected in the analysis of agglomeration tendencies so far. First, it regards regional agglomeration patterns and secondly, the allocation of capital across industrial sectors. Indeed, the average relative concentration of capital turns out to be of a higher level and variability than the one of employment in 1985-94. Regions marked by a relatively high uneven allocation of capital are also subject to lower economic performance than regions marked by a relatively low capital concentration. Though direct investments in services represent a large share of direct investments in the 1990s, relative specialisation in services is rather low, but steadily increasing from 1985-94 in EU countries and regions. --Regional Economics,Direct Investment,Capital Allocation,Factor Mobility

Barriers to Diversification and Regional Allocation of Capital

In order to evaluate the allocational effectiveness of regional policy when harmonizing regional economic conditions firms? preferences play a pivot role. If harmonization hinders risk diversification of the firm, then instead of regional diversification of capital agglomeration of capital occurs. Hence, regional policy will not achieve its objective to equal the spatial allocation of capital. --Regional policy,agglomeration,diversification,allocation,risk aversion,prudence

Fair Estimation of Capital Risk Allocation

In this paper we develop a novel methodology for estimation of risk capital allocation. The methodology is rooted in the theory of risk measures. We work within a general, but tractable class of law-invariant coherent risk measures, with a particular focus on expected shortfall. We introduce the concept of fair capital allocations and provide explicit formulae for fair capital allocations in case when the constituents of the risky portfolio are jointly normally distributed. The main focus of the paper is on the problem of approximating fair portfolio allocations in the case of not fully known law of the portfolio constituents. We define and study the concepts of fair allocation estimators and asymptotically fair allocation estimators. A substantial part of our study is devoted to the problem of estimating fair risk allocations for expected shortfall. We study this problem under normality as well as in a nonparametric setup. We derive several estimators, and prove their fairness and/or asymptotic fairness. Last, but not least, we propose two backtesting methodologies that are oriented at assessing the performance of the allocation estimation procedure. The paper closes with a substantial numerical study of the subject

Risk Based Capital Allocation

The present contribution reviews the procedures (absolute, incremental and marginal capital allocation) as well as the general principles (proportional allocation, covariance-principle, conditional expectation-principle, conditional value-at-risk principle, Euler-principle) for risk based capital allocation. The approaches discussed are applicable for the insurance case, the investment case and as well for credit risks.

Some results on Denault's capital allocation rule.

Denault (2001) introduces a capital allocation principle where the capital allocated to any risk unit is expressed in terms of the contribution of that risk to the aggregate conditional tail expectation. Panjer (2002) derives a closed-form expression for this allocation rule in the multivariate normal case. Landsman & Valdez (2003) generalize Panjer's result to the class of multivariate elliptical distributions. In this paper we provide an alternative and much simpler proof for the allocation formula in the elliptical case. Further, we show how to derive accurate closed-form approximations for Denault's allocation formula in case of lognormal risks.Capital allocation;