Economic capital allocation under liquidity constraints

Mierzejewski, Fernando (2006): Economic capital allocation under liquidity constraints. Published in: Proceedings of the 4th Actuarial and Financial Mathematics Day (2006): pp. 107-116.

Abstract

Since the capital structure affects the performance of financial institutions confronted to liquidity constraints, the Economic Capital is determined by the maximisation of value. Allowing economic decisions to be characterised by a distorted probability distribution, so assessing the attitude towards risk as well as information and knowledge, the optimal surplus is expressed as a Value-at-Risk, as recommended by the Basel Committee. Thus, demanding more capital than regulatory requirements accounts for different expectations about risks. The optimal surplus is allocated to the lines of business of a conglomerate according to the borne risk and the type of divisional managers. Full-allocation is assured and no covariances are required. Further, a mechanism is provided, which allows for the distribution of equity in a decentralised organisation.

• Item Type: MPRA Paper
• Institution: Katholieke Universiteit Leuven
• Language: English
• Keywords: economic capital; capital allocation; distorted probability principle; Value-at-Risk
• Subjects: G - Financial Economics > G3 - Corporate Finance and Governance > G38 - Government Policy and Regulation; G - Financial Economics > G3 - Corporate Finance and Governance > G33 - Bankruptcy ; Liquidation; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill

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