Risk Capital Allocation for RORAC Optimization

23 Pages Posted: 6 Jul 2010 Last revised: 31 Aug 2011

See all articles by Arne Buch

Arne Buch

affiliation not provided to SSRN

Gregor Dorfleitner

University of Augsburg - Department of Statistics and Mathematical Economic Theory; University of Regensburg - Department of Finance

Maximilian Wimmer

University of Regensburg; University of Mannheim - Finance Area

Date Written: February 21, 2011

Abstract

This paper considers the financial optimization problem of a firm with several sub-businesses striving for its optimal RORAC. An insightful example shows that the implementation of classical gradient capital allocation can be suboptimal if division managers are allowed to venture into all business whose marginal RORAC exceeds the firm's RORAC. The marginal RORAC requirements are refined by adding a risk correction term that takes into account the interdependencies of the risks of different lines of business. It is shown that under certain stationarity conditions this approach can guarantee that the optimal RORAC will eventually be achieved.

Keywords: Risk capital, Economic capital, Capital allocation, Gradient allocation, Euler allocation, RORAC

JEL Classification: C61, D81, D82, G21, G22

Suggested Citation

Buch, Arne and Dorfleitner, Gregor and Dorfleitner, Gregor and Wimmer, Maximilian, Risk Capital Allocation for RORAC Optimization (February 21, 2011). Journal of Banking and Finance, Vol. 35, pp. 3001-3009, 2011, Available at SSRN: https://ssrn.com/abstract=1634848

Arne Buch

affiliation not provided to SSRN ( email )

Gregor Dorfleitner

University of Regensburg - Department of Finance ( email )

Regensburg, 93040
Germany

University of Augsburg - Department of Statistics and Mathematical Economic Theory ( email )

Augsburg, 86135
Germany

Maximilian Wimmer (Contact Author)

University of Regensburg ( email )

Universitaetsstrasse 31
Regensburg, 93053
Germany
+49 941 943 2672 (Phone)

HOME PAGE: http://www-finance.uni-regensburg.de/Team/Maximilian-Wimmer.html

University of Mannheim - Finance Area ( email )

Mannheim, 68131
Germany

HOME PAGE: http://cf.bwl.uni-mannheim.de/

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