Euler Allocation for Performance Measurement

It is well known that if an Euler allocation is used to allocate capital by line, the overall expected return on capital can be increased by writing more business in lines where the expected return on allocated capital is greater than the overall expected return. If the cost of equity capital varies by line, however, writing more business in these lines may not be the best choice for the company. In this paper we give a simple example that highlights why an Euler allocation is not always appropriate for performance measurement if the cost of equity capital varies by line. Address for Correspondence: shayansen@hotmail.com