Holistic principle for risk aggregation and capital allocation

Wing Fung Chong, Runhuan Feng, Longhao Jin

Research output: Contribution to journalArticlepeer-review

3 Citations (Scopus)
71 Downloads (Pure)


Risk aggregation and capital allocation are of paramount importance in business, as they play critical roles in pricing, risk management, project financing, performance management, regulatory supervision, etc. The state-of-the-art practice often includes two steps: (i) determine standalone capital requirements for individual business lines and aggregate them at a corporate level; and (ii) allocate the total capital back to individual lines of business or at more granular levels. There are three pitfalls with such a practice, namely, lack of consistency, negligence of cost of capital, and disentanglement of allocated capitals from standalone capitals. In this paper, we introduce a holistic approach that aims to strike a balance of optimality by taking into account competing interests of various stakeholders and conflicting priorities in a corporate hierarchy. While unconventional in its objective, the new approach results in an allocation of diversification benefit, which conforms to the diversification strategy of many risk management frameworks including regulatory capital and economic capital. The holistic capital setting and allocation principle provides a remedy to aforementioned problems with the existing two-step industry practice.

Original languageEnglish
Pages (from-to)21-54
Number of pages34
JournalAnnals of Operations Research
Early online date26 Feb 2021
Publication statusPublished - Nov 2023


  • Capital allocation
  • Diversification benefit
  • Pareto optimality
  • Risk aggregation
  • Risk management

ASJC Scopus subject areas

  • General Decision Sciences
  • Management Science and Operations Research


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