Excess Based Allocation of Risk Capital

Research output: Working paperDiscussion paperOther research output

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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.
Original languageEnglish
Place of PublicationTilburg
PublisherOperations research
Number of pages38
Volume2010-123
Publication statusPublished - 2010

Publication series

NameCentER Discussion Paper
Volume2010-123

Fingerprint

Risk capital
Linear programming
Capital allocation
Expected loss
Allocation rules

Keywords

  • risk capital
  • capital allocation
  • excesses
  • lexicographic minimum

Cite this

van Gulick, G., De Waegenaere, A. M. B., & Norde, H. W. (2010). Excess Based Allocation of Risk Capital. (CentER Discussion Paper; Vol. 2010-123). Tilburg: Operations research.
van Gulick, G. ; De Waegenaere, A.M.B. ; Norde, H.W. / Excess Based Allocation of Risk Capital. Tilburg : Operations research, 2010. (CentER Discussion Paper).
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van Gulick, G, De Waegenaere, AMB & Norde, HW 2010 'Excess Based Allocation of Risk Capital' CentER Discussion Paper, vol. 2010-123, Operations research, Tilburg.

Excess Based Allocation of Risk Capital. / van Gulick, G.; De Waegenaere, A.M.B.; Norde, H.W.

Tilburg : Operations research, 2010. (CentER Discussion Paper; Vol. 2010-123).

Research output: Working paperDiscussion paperOther research output

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N2 - 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.

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van Gulick G, De Waegenaere AMB, Norde HW. Excess Based Allocation of Risk Capital. Tilburg: Operations research. 2010. (CentER Discussion Paper).