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Banking Firm and Two-Moment Decision Making

  • Broll, Udo
  • Wong, Wing-Keung
  • Wu, Mojia

The economic environment for financial institutions has become increasingly risky. Hence these institutions must find ways to manage risk of which one of the most important forms is interest rate risk. In this paper we use the mean-variance (mean-standard deviation) approach to examine a banking firm investing in risky assets and hedging opportunities. The mean-standard deviation framework can be used because our hedging model satisfies a scale and location condition. The focus of this study is on how interest rate risk affects optimal bank investment in the loan and deposit market when derivatives are available. Furthermore we explore the relationship among the first- and second-degree stochastic dominance efficient sets and the mean-variance efficient set.

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File URL: http://mpra.ub.uni-muenchen.de/51687/1/MPRA_paper_51687.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 51687.

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Date of creation: 23 Dec 2013
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Handle: RePEc:pra:mprapa:51687
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  1. Udo Broll & Jack E. Wahl & Wing-Keung Wong, 2005. "Elasticity of risk aversion and international trade," Monash Economics Working Papers 07/05, Monash University, Department of Economics.
  2. Loffler, Andreas, 1996. "Variance Aversion Implies[mu]-[sigma]2-Criterion," Journal of Economic Theory, Elsevier, vol. 69(2), pages 532-539, May.
  3. Tesfatsion, Leigh, 1976. "Stochastic Dominance and the Maximization of Expected Utility," Review of Economic Studies, Wiley Blackwell, vol. 43(2), pages 301-15, June.
  4. Wong, Wing-Keung, 2007. "Stochastic dominance and mean-variance measures of profit and loss for business planning and investment," European Journal of Operational Research, Elsevier, vol. 182(2), pages 829-843, October.
  5. Hadar, Josef & Russell, William R., 1971. "Stochastic dominance and diversification," Journal of Economic Theory, Elsevier, vol. 3(3), pages 288-305, September.
  6. Fong, Wai Mun & Wong, Wing Keung & Lean, Hooi Hooi, 2005. "International momentum strategies: a stochastic dominance approach," Journal of Financial Markets, Elsevier, vol. 8(1), pages 89-109, February.
  7. Lean, H.H. & McAleer, M.J. & Wong, W.K., 2010. "Investor preferences for oil spot and futures based on mean-variance and stochastic dominance," Econometric Institute Research Papers EI 2010-37, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  8. Egozcue, Martín & García, Luis Fuentes & Wong, Wing-Keung & Zitikis, Ricardas, 2011. "Do investors like to diversify? A study of Markowitz preferences," European Journal of Operational Research, Elsevier, vol. 215(1), pages 188-193, November.
  9. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, vol. 61(3), pages 589-611, May.
  10. Zhidong Bai & Hua Li & Huixia Liu & Wing‐Keung Wong, 2011. "Test statistics for prospect and Markowitz stochastic dominances with applications," Econometrics Journal, Royal Economic Society, vol. 14(2), pages 278-303, 07.
  11. Wagener, Andreas, 2002. "Prudence and risk vulnerability in two-moment decision models," Economics Letters, Elsevier, vol. 74(2), pages 229-235, January.
  12. Egozcue, Martin & Wong, Wing-Keung, 2010. "Gains from diversification on convex combinations: A majorization and stochastic dominance approach," European Journal of Operational Research, Elsevier, vol. 200(3), pages 893-900, February.
  13. Meyer, Jack, 1987. "Two-moment Decision Models and Expected Utility Maximization," American Economic Review, American Economic Association, vol. 77(3), pages 421-30, June.
  14. Lean, H.H. & McAleer, M.J. & Wong, W.K., 2010. "Market Efficiency of Oil Spot and Futures: A Stochastic Dominance Approach," Econometric Institute Research Papers EI 2010-11, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  15. Meyer, Jack, 1977. "Second Degree Stochastic Dominance with Respect to a Function," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 18(2), pages 477-87, June.
  16. Davis, George K, 1989. "Income and Substitution Effects for Mean-Preserving Spreads," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(1), pages 131-36, February.
  17. Sinn, Hans-Werner, 1990. " Expected Utility, mu-sigma Preferences, and Linear Distribution Classes: A Further Result," Journal of Risk and Uncertainty, Springer, vol. 3(3), pages 277-81, September.
  18. Hooi Hooi Lean & Michael McAleer & Wing-Keung Wong, 2010. "Market Efficiency of Oil Spot and Futures: A Mean-Variance and Stochastic Dominance Approach," Working Papers in Economics 10/18, University of Canterbury, Department of Economics and Finance.
  19. Baron, David P., 1974. "Information, Investment Behavior, and Efficient Portfolios," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 9(04), pages 555-566, September.
  20. Dominic Gasbarro & Wing-Keung Wong & J. Kenton Zumwalt, 2007. "Stochastic Dominance Analysis of iShares," SCAPE Policy Research Working Paper Series 0706, National University of Singapore, Department of Economics, SCAPE.
  21. Lam, Kin & Liu, Taisheng & Wong, Wing-Keung, 2010. "A pseudo-Bayesian model in financial decision making with implications to market volatility, under- and overreaction," European Journal of Operational Research, Elsevier, vol. 203(1), pages 166-175, May.
  22. Fong, Wai Mun & Lean, Hooi Hooi & Wong, Wing Keung, 2008. "Stochastic dominance and behavior towards risk: The market for Internet stocks," Journal of Economic Behavior & Organization, Elsevier, vol. 68(1), pages 194-208, October.
  23. Ormiston, Michael B & Schlee, Edward E, 2001. "Mean-Variance Preferences and Investor Behaviour," Economic Journal, Royal Economic Society, vol. 111(474), pages 849-61, October.
  24. Hanoch, G & Levy, Haim, 1969. "The Efficiency Analysis of Choices Involving Risk," Review of Economic Studies, Wiley Blackwell, vol. 36(107), pages 335-46, July.
  25. Chenghu Ma & Wing-Keung Wong, 2013. "Stochastic Dominance and Risk Measure: A Decision-Theoretic Foundation for VaR and C-VaR," Papers 2013-10-14, Working Paper.
  26. Chan, Chia-Ying & de Peretti, Christian & Qiao, Zhuo & Wong, Wing-Keung, 2012. "Empirical test of the efficiency of the UK covered warrants market: Stochastic dominance and likelihood ratio test approach," Journal of Empirical Finance, Elsevier, vol. 19(1), pages 162-174.
  27. Levy, Haim, 1989. "Two-Moment Decision Models and Expected Utility Maximization: Comment," American Economic Review, American Economic Association, vol. 79(3), pages 597-600, June.
  28. Whitmore, G A, 1970. "Third-Degree Stochastic Dominance," American Economic Review, American Economic Association, vol. 60(3), pages 457-59, June.
  29. Bar-Shira, Ziv & Finkelshtain, Israel, 1999. "Two-moments decision models and utility-representable preferences," Journal of Economic Behavior & Organization, Elsevier, vol. 38(2), pages 237-244, February.
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