Template-Type: ReDIF-Paper 1.0
Author-Name:  Jens Leth Hougaard
Author-Name-First: Jens Leth
Author-Name-Last: Hougaard
Author-Email: jlh@ifro.ku.dk
Author-Workplace-Name: Department of Food and Resource Economics, University of Copenhagen
Author-Name:  Aleksandrs Smilgins
Author-Name-First: Aleksandrs
Author-Name-Last: Smilgins
Author-Email: alsm@ifro.ku.dk
Author-Workplace-Name: Department of Food and Resource Economics, University of Copenhagen
Title: Risk Capital Allocation: The Lorenz Set
Abstract: Risk capital allocation problems have been widely discussed in the academic literature. We consider a company with multiple subunits having individual portfolios. Hence, when portfolios of subunits are merged, a diversification benefit arises: the risk of the company as a whole is smaller than the sum of the risks of the individual sub-units. The question is how to allocate the risk capital of the company among the subunits in a fair way. In this paper we propose to use the Lorenz set as an allocation method. We show that the Lorenz set is operational and coherent. Moreover, we propose a set of new axioms related directly to the problem of risk capital allocation and show that the Lorenz set satisfies these new axioms in contrast to other well-known coherent methods. Finally, we discuss how to deal with non-uniqueness of the Lorenz set.
Length: 20 pages
Creation-Date:  2014-05
File-URL: http://okonomi.foi.dk/workingpapers/MSAPpdf/MSAP2014/MSAP_WP03_2014.pdf
File-Format: Application/pdf
Number: 03_2014
Keywords: Risk capital, Cost allocation, Lorenz undominated elements of the core, Coherent risk allocation, Egalitarian allocation
Handle: RePEc:foi:msapwp:03_2014