Risk capital allocation for RORAC optimization?

This paper considers the financial optimization problem of a firm with several sub-businesses striving for its optimal RORAC. An insightful example shows that the  implementation of classical gradient capital allocation can be suboptimal if division managers are allowed to venture into all business whose marginal RORAC exceeds the firm’s RORAC. The marginal RORAC requirements are refined by adding a risk correction term that takes into account the interdependencies of the risks of different lines of business. It is shown that under certain stationary conditions this approach can guarantee that the optimal RORAC will eventually be achieved.

University of Regensburg
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Arne Buch, Gregor Dorfleitner, Maximilian Wimmer
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ResourceID: 69802

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