Optimal capital allocation principles considering capital shortfall and surplus risks in a hierarchical corporate structure

Jun Cai and Ying Wang

Insurance: Mathematics and Economics, 2021, vol. 100, issue C, 329-349

Abstract: When allocating a given total capital among main business lines and their sub-business lines, a decision maker will face both capital shortfall risk and capital surplus risk for each business line. There is a trade-off between the two kinds of risks. To balance such two kinds of risks in main business lines and their sub-business lines, we propose a capital allocation model considering both capital shortfall risks and capital surplus risks in a hierarchical corporate structure. We derive optimal allocation principles as solutions that minimize a general loss function that balances the shortfall and surplus risks. As applications of the proposed model, a general proportional allocation principle in the presence of a hierarchical corporate structure is derived. It is illustrated that the general proportional allocation can be viewed as the unique solution minimizing a specified loss function in the proposed model. Connections between this proposed model and some risk factors, such as dependence, extreme events, exogenous risks, and risk measures, are discussed.

Keywords: Optimal capital allocation; Extreme tail events; Risk measure; Generalized inverse function; Hierarchical corporate structure (search for similar items in EconPapers)
JEL-codes: C1 C6 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:100:y:2021:i:c:p:329-349

DOI: 10.1016/j.insmatheco.2021.06.005

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