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Multiobjective optimization of credit capital allocation in financial institutions

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Abstract

The evolution of international regulation leads to new capital requirements imposed on globally active companies. Financial services firms allocate capital to business lines in order to withstand the materializing credit losses and to measure the performance of various business lines. In this study, we introduce a methodology for optimal credit capital allocation based on operations research approach. In particular, we focus on the efficient allocation of capital to business lines characterized by credit risk losses and cost of capital. We compare different allocation methods and provide a rationale behind using the OR approach. Finally, we formulate a multiobjective optimization model to capital allocation problem and apply it to a real-world case of two financial conglomerates.

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Notes

  1. A solution \(Z\in S\) is said to dominate a solution \(Y\in S\) if \(f_i(Z)\le f_i(Y)\, \text{ for } \text{ all }\, i=1,2,\ldots ,m\) and \(f_j(Z)<f_j(Y)\) for at least one index \(1\le j\le m\). Moreover, \(Z\) is said to be not dominated by set \(S\) if there is no solution \(Y\in S\) that dominates \(Z\). In this case, \(Z\) is called nondominated or Pareto-optimal solution. The collection of all Pareto-optimal solutions is called the Pareto-optimal set and the graphical representation of these solutions in terms of their objective function values is called the efficient frontier.

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Authors and Affiliations

  1. Chair of Logistics Management, Department of Management, Technology, and Economics, Swiss Federal Institute of Technology Zurich, Weinbergstrasse 56/58, 8092, Zurich, Switzerland

    Kamil J. Mizgier

  2. UBS AG, Freischuetzgasse 25, 8004, Zurich, Switzerland

    Joseph M. Pasia

Authors
  1. Kamil J. Mizgier
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  2. Joseph M. Pasia
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Correspondence to Kamil J. Mizgier.

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The views expressed herein are those of the authors and not necessarily those of UBS, which does not accept any responsibility for the contents and opinions expressed in this paper.

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Mizgier, K.J., Pasia, J.M. Multiobjective optimization of credit capital allocation in financial institutions. Cent Eur J Oper Res 24, 801–817 (2016). https://doi.org/10.1007/s10100-015-0384-9

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