Capital Adequacy Tests and Limited Liability of Financial Institutions
26 Pages Posted: 2 Nov 2013 Last revised: 5 Nov 2015
Date Written: January 29, 2014
The theory of acceptance sets and their associated risk measures plays a key role in the design of capital adequacy tests. The objective of this paper is to investigate, in the context of bounded financial positions, the class of surplus-invariant acceptance sets. These are characterized by the fact that acceptability does not depend on the positive part, or surplus, of a capital position. We argue that surplus invariance is a reasonable requirement from a regulatory perspective, because it focuses on the interests of liability holders of a financial institution. We provide a dual characterization of surplus-invariant, convex acceptance sets, and show that the combination of surplus invariance and coherence leads to a narrow range of capital adequacy tests, essentially limited to scenario-based tests. Finally, we emphasize the advantages of dealing with surplus-invariant acceptance sets as the primary object rather than directly with risk measures, such as loss-based and excess-invariant risk measures, which have been recently studied by Cont, Deguest & He and by Staum, respectively.
Keywords: surplus invariance, limited liability, capital adequacy, risk measures, loss-based risk measures, shortfall risk measures, excess invariance
JEL Classification: C60, G11, G22
Suggested Citation: Suggested Citation