21 Pages Posted: 16 Dec 2010
Date Written: December 14, 2010
A key firm in the recent crisis has been AIG. Its CDS financial intermediation tried to function on too thin layer of capital – high leverage – owing to a misreading of the degree of risk embodied in ever more complex financial products and markets. I explain why the application of stochastic optimal control (SOC)/dynamic risk management is an effective approach to determine the optimal capital requirement and the optimum risk for a large insurer and the probability of a debt crisis. The theoretically derived early warning signal of a crisis is the excess liability ratio, equal to the difference between the actual and optimal ratio.
Keywords: AIG, Insurance, Stochastic Optimal Control, Optimal Capital Requirements, Risk, Financial Crises
JEL Classification: C61, D81, D91, G1, G11, G12, G14
Suggested Citation: Suggested Citation
Stein, Jerome L., Optimal Capital Requirements for a Large Insurer/AIG: A Stochastic Optimal Control Approach (December 14, 2010). Available at SSRN: https://ssrn.com/abstract=1725594 or http://dx.doi.org/10.2139/ssrn.1725594