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;

Who Invests in Home Equity to Exempt Wealth from Bankruptcy?

Homestead exemptions to personal bankruptcy allow households to retain their home equity up to a limit determined at the state level. Households that may experience bankruptcy thus have an incentive to bias their portfolios towards home equity. Using US household data from the Survey of Income and Program Participation for the period 1996-2006, we find that especially households with low net worth maintain a larger share of their wealth as home equity if a larger homestead exemption applies. This home equity bias is also more pronounced if the household head is in poor health, increasing the chance of bankruptcy on account of unpaid medical bills. The bias is further stronger for households with mortgage finance, shorter house tenures, and younger household heads, which taken together reflect households that face more financial uncertainty.Homestead exemptions;Personal bankruptcy;Portfolio allocation;Home ownership

Risk measurement with the equivalent utility principles.

Risk measures have been studied for several decades in the actuarial literature, where they appeared under the guise of premium calculation principles. Risk measures and properties that risk measures should satisfy have recently received considerable at- tention in the financial mathematics literature. Mathematically, a risk measure is a mapping from a class of random variables defined on some measurable space to the (extended) real line. Economically, a risk measure should capture the preferences of the decision-maker. In incomplete financial markets, prices are no more unique but depend on the agents' attitudes towards risk. This paper complements the study initiated in Denuit, Dhaene & Van Wouwe (1999) and considers several theories for decision under uncertainty: the classical expected utility paradigm, Yaari's dual approach, maximin expected utility theory, Choquet expected utility theory and Quiggin rank-dependent utility theory. Building on the actuarial equivalent utility pricing principle, broad classes of risk measures are generated, of which most classical risk measures appear to be particular cases. This approach shows that most risk measures studied recently in the financial literature disregard the utility concept (i.e. correspond to linear utilities), causing some deficiencies. Some alternatives proposed in the literature are discussed, based on exponential utilities.Actuarial; Coherence; Decision; Expected; Market; Markets; Measurement; Preference; Premium; Prices; Pricing; Principles; Random variables; Research; Risk; Risk measure; Risk measurement; Space; Studies; Theory; Uncertainty; Utilities; Variables;

Finance, firm size and growth.

[Dataset available: http://hdl.handle.net/10411/15986]