Portfolio Optimization Under Solvency II: Implicit Constraints Imposed by the Market Risk Standard Formula

29 Pages Posted: 17 Aug 2013

See all articles by Alexander Braun

Alexander Braun

University of St. Gallen - I.VW-HSG

Hato Schmeiser

University of Muenster - Faculty of Economics; University of St. Gallen - I.VW-HSG

Florian Schreiber

University of St. Gallen - I.VW-HSG

Date Written: June 10, 2013

Abstract

We consider the issue of optimizing an insurance company's asset allocation in the context of portfolio theory when the firm needs to adhere to the market risk capital requirements of Solvency II. The discussion starts with a brief review of the standard formula and the introduction of a parsimonious partial internal model. Subsequently, we estimate empirical risk-return profiles for the main asset classes held by insurers and run a quadratic optimization program to derive nondominated frontiers with budget, short-sale, and investment constraints. We then compute the respective capital charges under both solvency models and identify those efficient portfolio compositions that are permitted for an exogenously given amount of equity. Finally, we consider a systematically selected set of inefficient portfolios and check their admissibility, too. Our results document that the standard formula is unable to distinguish investments on the basis of risk-return profiles and does hence not produce economically sensible results. Therefore, the introduction of Solvency II in its current form might cause severe asset management biases in the European insurance sector.

Keywords: Portfolio Theory, Solvency II, Market Risk, Asset Management

JEL Classification: G11, G22, G28, G32, G38

Suggested Citation

Braun, Alexander and Schmeiser, Hato and Schreiber, Florian, Portfolio Optimization Under Solvency II: Implicit Constraints Imposed by the Market Risk Standard Formula (June 10, 2013). Available at SSRN: https://ssrn.com/abstract=2291561 or http://dx.doi.org/10.2139/ssrn.2291561

Alexander Braun

University of St. Gallen - I.VW-HSG ( email )

Kirchlistrasse 2
St. Gallen, 9010
Switzerland

Hato Schmeiser

University of Muenster - Faculty of Economics ( email )

Universitätsstr. 14-16
48143 Munster
Germany

University of St. Gallen - I.VW-HSG ( email )

Kirchlistrasse 2
St. Gallen, 9010
Switzerland

Florian Schreiber (Contact Author)

University of St. Gallen - I.VW-HSG ( email )

Tannenstrasse 19
St. Gallen, 9010
Switzerland

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