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Evaluating Capital Allocation Below Portfolio Level

Sandwall, Philip and Ågren, Oscar (2013) FMS820 20132
Mathematical Statistics
Abstract (Swedish)
This thesis explores the ability for retail banks to allocate economic capital below portfolio
level. First, a discussion about capital requirements and risk measures to provide
a sound basis for determining the economic capital of the bank. In general, economic
capital is allocated to the banks portfolios but not on a more granular level, through a
capital allocation method. This study discuss three dierent approaches for allocation
of economic capital below portfolio level; game theory, nance and optimization. Both
the game theory and nance approach reach the same conclusion, that the best allocation
principle is the gradient of the risk measure. The optimization method allocates
economic capital through minimization of a concept... (More)
This thesis explores the ability for retail banks to allocate economic capital below portfolio
level. First, a discussion about capital requirements and risk measures to provide
a sound basis for determining the economic capital of the bank. In general, economic
capital is allocated to the banks portfolios but not on a more granular level, through a
capital allocation method. This study discuss three dierent approaches for allocation
of economic capital below portfolio level; game theory, nance and optimization. Both
the game theory and nance approach reach the same conclusion, that the best allocation
principle is the gradient of the risk measure. The optimization method allocates
economic capital through minimization of a concept called risk residual, which conclude
that the optimal allocation is derived from the marginal distribution of a customer. Capital
allocation below portfolio level give the management a good overview of risks from
dierent customers. In order to determine the performance of the portfolios in the bank
a Risk-Adjusted-Return-On-Capital is used, with economic capital as input. The thesis
include some comments about how the choice of capital allocation methods aect the
performance measurement. The thesis concludes with an evaluation of the methods by
simulations of a ctional bank conducted in the software R.
Key Words: Risk Appetite, Economic Capital, Risk measure, Capital Allocation Methods,
Allocation Below Portfolio level, Game theory, Optimization, Marginal Contribution (Less)
Please use this url to cite or link to this publication:
author
Sandwall, Philip and Ågren, Oscar
supervisor
organization
course
FMS820 20132
year
type
H2 - Master's Degree (Two Years)
subject
language
English
id
4022760
date added to LUP
2013-09-10 11:59:18
date last changed
2013-09-10 11:59:18
@misc{4022760,
  abstract     = {This thesis explores the ability for retail banks to allocate economic capital below portfolio
level. First, a discussion about capital requirements and risk measures to provide
a sound basis for determining the economic capital of the bank. In general, economic
capital is allocated to the banks portfolios but not on a more granular level, through a
capital allocation method. This study discuss three dierent approaches for allocation
of economic capital below portfolio level; game theory, nance and optimization. Both
the game theory and nance approach reach the same conclusion, that the best allocation
principle is the gradient of the risk measure. The optimization method allocates
economic capital through minimization of a concept called risk residual, which conclude
that the optimal allocation is derived from the marginal distribution of a customer. Capital
allocation below portfolio level give the management a good overview of risks from
dierent customers. In order to determine the performance of the portfolios in the bank
a Risk-Adjusted-Return-On-Capital is used, with economic capital as input. The thesis
include some comments about how the choice of capital allocation methods aect the
performance measurement. The thesis concludes with an evaluation of the methods by
simulations of a ctional bank conducted in the software R.
Key Words: Risk Appetite, Economic Capital, Risk measure, Capital Allocation Methods,
Allocation Below Portfolio level, Game theory, Optimization, Marginal Contribution},
  author       = {Sandwall, Philip and Ågren, Oscar},
  language     = {eng},
  note         = {Student Paper},
  title        = {Evaluating Capital Allocation Below Portfolio Level},
  year         = {2013},
}