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Post by Sapphire Capital on Aug 14, 2008 21:36:56 GMT 4
An Economic Approach to Capital Allocation George H. Zanjani Georgia State University - Risk Management & Insurance Department June 25, 2008 Abstract: This paper starts with primitive assumptions on consumer preferences and risk. It then derives prices consistent with a social optimum within an insurance company and the consumer-level capital allocation implied therein. The implied allocation "adds up" to the total capital of the firm (a result echoing findings in the congestion pricing literature - where optimal tolls exactly cover the rental cost of the highway). The allocation follows each consumer's share of recoveries in states where the insurer defaults, weighted by the severity of the default in terms of welfare impact. The paper goes on to argue that the economic approach employed supports a broader conception of allocation - beyond that based on the marginal impact of each consumer's risk. Specifically, it shows that marginal allocation rules do restrict the capital assigned to marginal units of coverage, but inframarginal units of coverage may in general receive different assignments of capital. papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1151455_code238092.pdf?abstractid=1151455&mirid=3
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