Publication date: Available online 14 April 2018
Source:Insurance: Mathematics and Economics
Author(s): Stefan Weber
Under Solvency II the computation of capital requirements is based on value at risk (V@R). V@R is a quantile-based risk measure and neglects extreme risks in the tail. V@R belongs to the family of distortion risk measures. A serious deficiency of V@R is that firms can hide their total downside risk in corporate networks, unless a consolidated solvency balance sheet is required for each economic scenario. In this case, they can largely reduce their total capital requirements via appropriate transfer agreements within a network structure consisting of sufficiently many entities and thereby circumvent capital regulation. We prove several versions of such a result for general distortion risk measures of V@R-type, explicitly construct suitable allocations of the network portfolio, and finally demonstrate how these findings can be extended beyond distortion risk measures. We also discuss why consolidation requirements cannot completely eliminate this problem. Capital regulation should thus be based on coherent or convex risk measures like average value at risk or expectiles.
Source:Insurance: Mathematics and Economics
Author(s): Stefan Weber