The banking firm and risk taking in a two-moment decision model

We analyze a bank's risk taking in a two-moment decision framework. Our approach offers desirable properties like simplicity, intuitive interpretation, and empirical applicability. The bank's optimal behavior to a change in the standard deviation or the expected value of the risky asset�...

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Bibliographic Details
Published in:Economic modelling 2015-11, Vol.50, p.275-280
Main Authors: Broll, Udo, Guo, Xu, Welzel, Peter, Wong, Wing-Keung
Format: Article
Language:English
Subjects:
Bank portfolios
Banking firm
Decision making models
Elasticity
Elasticity of risk aversion
Expected values
Preferences
Rates of return
Risk aversion
Risk taking
Studies
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Summary:We analyze a bank's risk taking in a two-moment decision framework. Our approach offers desirable properties like simplicity, intuitive interpretation, and empirical applicability. The bank's optimal behavior to a change in the standard deviation or the expected value of the risky asset's or portfolio's return can be described in terms of risk aversion elasticities, i.e., the sensitivity of the marginal rate of substitution between risk and return. The bank's investment in a risky asset position goes down when the return risk increases, if and only if the risk aversion elasticity exceeds −1. •Modeling a banking firm we analyze risk taking in a two-moment decision model.•Depending on its risk aversion elasticity a bank will optimally increase its position in risky assets.•Risk taking can be described by the sensitivity of the marginal rate of substitution between risk and return.•Risk aversion elasticity turns out to be crucial for the effectiveness of capital adequacy regulation.
ISSN:0264-9993
1873-6122
DOI:10.1016/j.econmod.2015.06.016