Optimal capital allocation in a hierarchical corporate structure

Yaniv Zaks and Andreas Tsanakas

Insurance: Mathematics and Economics, 2014, vol. 56, issue C, 48-55

Abstract: We consider capital allocation in a hierarchical corporate structure where stakeholders at two organizational levels (e.g., board members vs line managers) may have conflicting objectives, preferences, and beliefs about risk. Capital allocation is considered as the solution to an optimization problem whereby a quadratic deviation measure between individual losses (at both levels) and allocated capital amounts is minimized. Thus, this paper generalizes the framework of Dhaene et al. (2012), by allowing potentially diverging risk preferences in a hierarchical structure. An explicit unique solution to this optimization problem is given. In several examples, it is shown how the optimal capital allocation achieves a compromise between conflicting views of risk within the organization.

Keywords: Capital allocation; Solvency II; Basel II; Weighted capital allocation; Hierarchical firms (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:56:y:2014:i:c:p:48-55

DOI: 10.1016/j.insmatheco.2014.02.009

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