Allocation of risk capital based on iso-entropic coherent risk measure
Abstract: The potential of
diversified portfolio leads to the risk capital allocation problem. There are
many kinds of methods or rules to allocate risk capital. However, they have flaws, such as
non-continuity, unfairness. In order to get a better method, we propose a new
risk measure to be the base of risk capital allocation rule.
Design/methodology/approach: We proposed two kinds of allocation methods:
one is marginal risk contribution based on iso-entropic coherent risk
measure(IE), the other one is to combine the minimal excess allocation(EBA)
principle and IE into risk capital allocation. The iso-entropic coherent risk
measure has many advantages over others; it is continuous and more powerful in
distinguishing risks, consistent with higher-order stochastic dominances than
other risk measures. And EBA is consistent with the amount of risk, which means
fairness for risk capital allocation.
Findings: Through cases, simulations and empirical application, it shows
that these two allocation rules satisfy some good properties, can be more efficient,
more precise and fairer. And the EBA based on IE may be the better one.
Research limitations/implications: However, there are some problems still
open. One is how to treat the negative value of allocation. Second is that the
consistence between the allocated risk capital and the amount of the risk needs
to be studied further.
Originality/value: A good risk measure is very important for risk capital
allocation. We proposed two methods to deal with risk capital allocation based
on a new coherent risk measure called iso-entropic risk measure, which is
smooth and consistent with higher-order stochastic dominance and has higher
resolution of risk. It shows that the risk capital allocation rules based on
iso-entropic risk measure are better than the other rules.
Keywords: risk capital
allocation; marginal risk contribution; minimal excess principle; iso-entropic
coherent risk measure
Author: Chengli Zheng, Yan
Chen
Journal Code: jptindustrigg150056
