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The Economic Capital Of Opaque Financial Institutions

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  • Fernando MIERZEJEWSKI

Abstract

The capital structure of firms that cannot hedge continuously is affected by the agency costs and the moral-hazard implicit in the contracts they establish with stockholders and customers. It is demonstrated in this paper that then an optimal level of capital exists, which is characterised in terms of the actuarial prices of the involved agreements. The capital principle so obtained extends the classic theoretical framework, sustained by the well-known proposition of Modigliani and Miller and the model of deposit insurance of Robert Merton, at the time that naturally integrates the financial and actuarial theoretical settings.

Suggested Citation

  • Fernando MIERZEJEWSKI, 2008. "The Economic Capital Of Opaque Financial Institutions," Journal of Applied Economic Sciences, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, vol. 3(3(5)_Fall), pages 232-245.
    • Handle: RePEc:ush:jaessh:v:3:y:2008:i:3(5)_fall2008:p:232-245
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    References listed on IDEAS

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    1. Robert C. Merton, 1997. "A Model of Contract Guarantees for Credit-Sensitive, Opaque Financial Intermediaries," Review of Finance, European Finance Association, vol. 1(1), pages 1-13.
    2. Jan Dhaene & Mark Goovaerts & Rob Kaas, 2003. "Economic Capital Allocation Derived from Risk Measures," North American Actuarial Journal, Taylor & Francis Journals, vol. 7(2), pages 44-56.
    3. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    4. Robert C. Merton & André Perold, 1993. "Theory Of Risk Capital In Financial Firms," Journal of Applied Corporate Finance, Morgan Stanley, vol. 6(3), pages 16-32, September.
    5. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    6. David Cummins, J. & Sommer, David W., 1996. "Capital and risk in property-liability insurance markets," Journal of Banking & Finance, Elsevier, vol. 20(6), pages 1069-1092, July.
    7. Marc Goovaerts & Eddy Van den Borre & Roger Laeven, 2005. "Managing Economic and Virtual Economic Capital Within Financial Conglomerates," North American Actuarial Journal, Taylor & Francis Journals, vol. 9(3), pages 77-89.
    8. Stephen A. Ross, 1989. "Institutional Markets, Financial Marketing, and Financial Innovation," Journal of Finance, American Finance Association, vol. 44(3), pages 541-556, July.
    9. Stephen A. Ross, 1989. "Institutional Markets, Financial Marketing, and Financial Innovation," Journal of Finance, American Finance Association, vol. 44(3), pages 541-556, July.
    10. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. "Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-1658, December.
    11. Fama, Eugene F, 1980. "Agency Problems and the Theory of the Firm," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 288-307, April.
    12. Laeven, Roger J. A. & Goovaerts, Marc J., 2004. "An optimization approach to the dynamic allocation of economic capital," Insurance: Mathematics and Economics, Elsevier, vol. 35(2), pages 299-319, October.
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    Cited by:

    1. Mierzejewski, Fernando, 2008. "The optimal liquidity principle with restricted borrowing," MPRA Paper 12549, University Library of Munich, Germany.
    2. Fernando MIERZEJEWSKI & Katholieke Universiteit, 2009. "Towards A General Theory Of Liquidity Preference," Journal of Applied Economic Sciences, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, vol. 4(2(8)_ Sum).

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    More about this item

    Keywords

    capital structure; economic capital; risk capital; deposit insurance; Value-at-Risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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