Risk-adjusted measures of value creation in financial institutions
AbstractMeasuring value creation by comparing the RAROC of an exposure (the return on risk capital) with a single institution-wide hurdle rate is inconsistent with the standard theory of financial valuation. We use asset pricing theory to determine the appropriate hurdle rate for such a RAROC performance measure. We find that this hurdle rate varies with the skewness of asset returns. Thus the RAROC hurdle rate should differ substantially between equity which has a right skew and debt which has a pronounced left skew and also between different qualities of debt exposure. We discuss implications for financial institution risk management and supervision.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Bank of Finland in its series Research Discussion Papers with number 25/2009.
Length: 37 pages
Date of creation: 02 Nov 2009
Date of revision:
asset pricing; banking; capital allocation; capital budgeting; capital management; corporate finance; downside risk; economic capital; performance measurement; RAROC; risk management; value creation; hurdle rate; value at risk;
Find related papers by JEL classification:
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-12-11 (All new papers)
- NEP-BAN-2009-12-11 (Banking)
- NEP-BEC-2009-12-11 (Business Economics)
- NEP-CFN-2009-12-11 (Corporate Finance)
- NEP-RMG-2009-12-11 (Risk Management)
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Alistair Milne, 2010. "Macro-Prudential Policy: An Assessment," CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, vol. 8(1), pages 28-33, 04.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Minna Nyman).
If references are entirely missing, you can add them using this form.