Optimal captial investment for an insurance company

Abstract

The purpose of this study was to investigate a common problem of managing economic capital for insurance companies. In particular, the role of determining the optimal investment capital and investing the capital in a well diversified portfolio were examined. The optimization problem incorporated in our methodology, was constructed to solve the optimal investment capital under ruin probability constraint in such a way that it jointly optimizes the asset allocation among a diversified portfolio. Our approach has a semipara­metric nature with appropriate transformations and approximations that enable numerical techniques such as Monte Carlo simulation. Asset returns were modelled using Multivariate Generalized Autoregressive Conditional Heteroskedastic (MV GARCH) framework. We implemented different correlation models targeting two risky assets. A rolling win­dow technique was employed to ensure the robustness of our models. It was revealed that the characteristics of the risky and risk-less assets and their behaviour over the moving in­vestment horizon, have great impact on investment plans. Our results indicated the optimal asset allocation in a well-diversified portfolio provided that investment capital is optimized subject to regulatory constraints.