Excess Based Allocation of Risk Capital

CentER Discussion Paper Series No. 2010-123

38 Pages Posted: 8 Dec 2010

See all articles by Gerwald van Gulick

Gerwald van Gulick

Tilburg University - Tilburg University School of Economics and Management

Anja De Waegenaere

Tilburg University - Department of Econometrics & OR, Netspar, and CentER

Henk Norde

Tilburg University - Center For Economic Research; Tilburg University - Department of Econometrics & Operations Research

Multiple version iconThere are 2 versions of this paper

Date Written: December 3, 2010

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 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.

Keywords: risk capital, capital allocation, excesses, lexicographic minimum

JEL Classification: G10, C61, C71

Suggested Citation

van Gulick, Gerwald and De Waegenaere, Anja M.B. and Norde, Henk W., Excess Based Allocation of Risk Capital (December 3, 2010). CentER Discussion Paper Series No. 2010-123. Available at SSRN: https://ssrn.com/abstract=1721519 or http://dx.doi.org/10.2139/ssrn.1721519

Gerwald Van Gulick

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Anja M.B. De Waegenaere (Contact Author)

Tilburg University - Department of Econometrics & OR, Netspar, and CentER ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Henk W. Norde

Tilburg University - Center For Economic Research ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 3245 (Phone)

Tilburg University - Department of Econometrics & Operations Research ( email )

Tilburg, 5000 LE
Netherlands

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