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The Impact of Capital Structure on Economic Capital and Risk Adjusted Performance

Published online by Cambridge University Press:  17 April 2015

Bruce T. Porteous  and
Pradip Tapadar
Bruce T. Porteous
Affiliation:
UK Risk Capital Development, Standard Life UK Financial Services, 30 Lothian Road, Edinburgh, EH1 2DH. Telephone: 0044-131 245 9307. E-Mail (work): [email protected] E-Mail (personal): [email protected]
Pradip Tapadar
Affiliation:
Institute of Mathematics, Statistics and Actuarial Science, Cornwallis Building, University of Kent, Canterbury, CT2 7NF. Telephone: 0044-1227 824 169. E-Mail (work): [email protected], E-Mail (personal): [email protected]
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Abstract

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The impact that capital structure and capital asset allocation have on financial services firm economic capital and risk adjusted performance is considered. A stochastic modelling approach is used in conjunction with banking and insurance examples. It is demonstrated that gearing up Tier 1 capital with Tier 2 capital can be in the interests of bank Tier 1 capital providers, but may not always be so for insurance Tier 1 capital providers. It is also shown that, by allocating a bank or insurance firm’s Tier 1 and Tier 2 capital to higher yielding, more risky assets, risk adjusted performance can be enhanced. These results are particularly pertinent with the advent of the new Basel 2 and Solvency 2 risk based capital initiatives, for banks and insurers respectively.

Keywords

Asset allocationcapital gearingeconomic capitalfinancial services firms risk adjusted performancestochastic modelsTier 1 and Tier 2 capital
Type
Articles
Information
ASTIN Bulletin: The Journal of the IAA , Volume 38 , Issue 1 , May 2008 , pp. 341 - 380
Copyright
Copyright © ASTIN Bulletin 2008

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