Risk based capital allocation

Dóra Balog

A chapter in Proceedings of FIKUSZ 2010, 2010, pp 17-26 from Óbuda University, Keleti Faculty of Business and Management

Abstract: Several methods are known for the purpose of capital allocation. There are some properties that allocation methods should satisfy. These are full allocation, core compatibility, riskless allocation and suitability for performance measurement (compatible with Return on Risk Adjusted Capital calculation). When we think about practical application we should also consider simplicity of the methods. We examine six methods from the point of view if they are satisfying the mentioned criteria and try to find out if there is any of them fulfilling both five properties. Our main question is the fulfillment of core compatibility that we test using simulation. We find that the Expected Shortfall based Euler method satisfies all the above given criteria but symmetry (that is not anyways desirable as we will point out) and also very easy to calculate. All this enables us to suggest this method for practical applications.

Date: 2010
ISBN: 978-615-5018-05-3
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